Derivatives and Hedging Activities

12 Months Ended

Dec. 31, 2018

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivatives and Hedging Activities

8. Derivatives and Hedging Activities

We are a party to various derivative instruments, mainly through our subsidiary, KeyBank. The primary derivatives that we use are interest rate swaps, caps, floors, forwards and futures; foreign exchange contracts; commodity derivatives; and credit derivatives. These instruments help us manage exposure to interest rate risk, mitigate the credit risk inherent in our loan portfolio, hedge against changes in foreign currency exchange rates, and meet client financing and hedging needs. As further discussed in this note:

• interest rate risk is the risk that the EVE or net interest income will be adversely affected by fluctuations in interest rates;

• credit risk is the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms; and

• foreign exchange risk is the risk that an exchange rate will adversely affect the fair value of a financial instrument.

At December 31, 2018, after taking into account the effects of bilateral collateral and master netting agreements, we had $69 million of derivative assets and a positive $9 million of derivative liabilities that relate to contracts entered into for hedging purposes. As of the same date, after taking into account the effects of bilateral collateral and master netting agreements and a reserve for potential future losses, we had derivative assets of $462 million and derivative liabilities of $395 million that were not designated as hedging instruments. These positions are primarily comprised of derivative contracts entered into for client accommodation purposes.

Additional information regarding our accounting policies for derivatives is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Derivatives and Hedging.”

Derivatives Designated in Hedge Relationships

Net interest income and the EVE change in response to changes in the mix of assets, liabilities, and off-balance sheet instruments and the associated interest rates tied to each instrument. In addition, differences in the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities cause net interest income and the EVE to fluctuate. We utilize derivatives that have been designated as part of a hedge relationship in accordance with the applicable accounting guidance to manage net interest income and EVE to within our stated risk tolerances. The primary derivative instruments used to manage interest rate risk are interest rate swaps.

We designate certain “receive fixed/pay variable” interest rate swaps as fair value hedges. These contracts convert certain fixed-rate long-term debt into variable-rate obligations, thereby modifying our exposure to changes in interest rates. As a result, we receive fixed-rate interest payments in exchange for making variable-rate payments over the lives of the contracts without exchanging the notional amounts.

Similarly, we designate certain “receive fixed/pay variable” interest rate swaps as cash flow hedges. These contracts effectively convert certain floating-rate loans into fixed-rate loans to reduce the potential adverse effect of

interest rate decreases on future interest income. Again, we receive fixed-rate interest payments in exchange for making variable-rate payments over the lives of the contracts without exchanging the notional amounts.

We designate interest rate floors as cash flow hedges. Interest rate floors also reduce the potential adverse effect of interest rate decreases on future interest income. We receive interest payments when the strike price specified in the contracts falls below a reference rate in exchange for an upfront premium.

We designate certain “pay fixed/receive variable” interest rate swaps as cash flow hedges. These swaps convert certain floating-rate debt into fixed-rate debt. We also use these swaps to manage the interest rate risk associated with anticipated sales of certain commercial real estate loans. The swaps protect against the possible short-term decline in the value of the loans that could result from changes in interest rates between the time they are originated and the time they are sold.

We use foreign currency forward transactions to hedge the foreign currency exposure of our net investment in various foreign equipment finance entities. These entities are denominated in a non-U.S. currency. These swaps are designated as net investment hedges to mitigate the exposure of measuring the net investment at the spot foreign exchange rate.

Derivatives Not Designated in Hedge Relationships

We may enter into interest rate swap contracts to manage economic risks but do not designate the instruments in hedge relationships. Excluding contracts addressing customer exposures, the amount of derivatives hedging risks on an economic basis at December 31, 2018, was not significant.

Like other financial services institutions, we originate loans and extend credit, both of which expose us to credit risk. We actively manage our overall loan portfolio and the associated credit risk in a manner consistent with asset quality objectives and concentration risk tolerances to mitigate portfolio credit risk. Purchasing credit protection through default swaps enables us to transfer to a third party a portion of the credit risk associated with a particular extension of credit, including situations where there is a forecasted sale of loans. We purchase credit default swaps to reduce the credit risk associated with the debt securities held in our trading portfolio.

We also enter into derivative contracts for other purposes, including:

• interest rate swap, cap, and floor contracts entered into generally to accommodate the needs of commercial loan clients;

• energy and base metal swap and option contracts entered into to accommodate the needs of clients;

• foreign exchange forward and option contracts entered into primarily to accommodate the needs of clients; and

• futures contracts and positions with third parties that are intended to offset or mitigate the interest rate or market risk related to client positions discussed above.

Fair Values, Volume of Activity, and Gain/Loss Information Related to Derivative Instruments

The following table summarizes the fair values of our derivative instruments on a gross and net basis as of December 31, 2018, and December 31, 2017. The change in the notional amounts of these derivatives by type from December 31, 2017, to December 31, 2018, indicates the volume of our derivative transaction activity during 2018. The notional amounts are not affected by bilateral collateral and master netting agreements. The derivative asset and liability balances are presented on a gross basis, prior to the application of bilateral collateral and master netting agreements. Total derivative assets and liabilities are adjusted to take into account the impact of legally enforceable master netting agreements that allow us to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related cash collateral. Where master netting agreements are not in effect or are not enforceable under bankruptcy laws, we do not adjust those derivative assets and liabilities with counterparties. Securities collateral related to legally enforceable master netting agreements is not offset on the balance sheet. Our derivative instruments are included in “accrued income and other assets” or “accrued expenses and other liabilities” on the balance sheet, as indicated in the following table:

	December 31, 2018								December 31, 2017
			Fair Value								Fair Value
in millions	Notional Amount		Derivative Assets			Derivative Liabilities			Notional Amount		Derivative Assets			Derivative Liabilities
Derivatives designated as hedging instruments:
Interest rate	$	28,546	$	50		$	(10	)	$	26,176	$	81		$	46
Foreign exchange	122		2			—			302		1			4
Total	28,668		52			(10		)	26,478		82			50
Derivatives not designated as hedging instruments:
Interest rate	63,454		365			307			61,390		641			474
Foreign exchange	6,829		104			95			8,317		129			120
Commodity	2,002		333			323			1,687		255			246
Credit	226		1			1			315		1			4
Other (a)	1,466		9			7			2,006		4			13
Total	73,977		812			733			73,715		1,030			857
Netting adjustments (b)	—		(333		)	(337		)	—		(443		)	(616		)
Net derivatives in the balance sheet	102,645		531			386			100,193		669			291
Other collateral (c)	—		(2		)	(33		)	—		(5		)	(84		)
Net derivative amounts	$	102,645	$	529		$	353		$	100,193	$	664		$	207

 

(a) Other derivatives include interest rate lock commitments and forward sale commitments related to our residential mortgage banking activities, forward purchase and sales contracts consisting of contractual commitments associated with “to be announced” securities and when issued securities, and when-issued security transactions in connection with an “at-the-market” equity offering program.

(b) Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance.

(c) Other collateral represents the amount that cannot be used to offset our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance. The other collateral consists of securities and is exchanged under bilateral collateral and master netting agreements that allow us to offset the net derivative position with the related collateral. The application of the other collateral cannot reduce the net derivative position below zero. Therefore, excess other collateral, if any, is not reflected above.

Fair value hedges. During the year ended December 31, 2018, we did not exclude any portion of these hedging instruments from the assessment of hedge effectiveness.

The following table summarizes the amounts that were recorded on the balance sheet as of December 31, 2018, related to cumulative basis adjustments for fair value hedges.

	December 31, 2018
in millions	Balance sheet line item in which the hedge item is included	Carrying amount of hedged item (a)		Hedge accounting basis adjustment (b)
Interest rate contracts	Long-term debt	$	9,363	$	(6	)
Interest rate contracts	Certificate of deposit ($100,000 or more)	343		(1		)
Interest rate contracts	Other time deposits	178		—

(a) The carrying amount represents the portion of the liability designated as the hedged item.

(b) Basis adjustment includes $10 million related to de-designated hedged items no longer in qualifying fair value hedging relationships.

Cash flow hedges. During the year ended December 31, 2018, we did not exclude any portion of these hedging instruments from the assessment of hedge effectiveness.

Considering the interest rates, yield curves, and notional amounts as of December 31, 2018, we would expect to reclassify an estimated $38 million of after-tax net gains on derivative instruments from AOCI to income during the next 12 months for our cash flow hedges. In addition, we expect to reclassify approximately $31 million of net losses related to terminated cash flow hedges from AOCI to income during the next 12 months. As of December 31, 2018, the maximum length of time over which we hedge forecasted transactions is 10 years.

The following tables summarize the effect of fair value and cash flow hedge accounting on the income statement for the years ended December 31, 2018, December 31, 2017, and December 31, 2016.

	Location and amount of net gains (losses) recognized in income on fair value and cash flow hedging relationships (a)
in millions	Interest expense – long-term debt			Interest income – loans			Investment banking and debt placement fees		Interest expense – deposits			Other income
Year ended December 31, 2018
Total amounts presented in the consolidated statement of income	$	(420	)	$	4,023		$	650	$	(517	)	$	176
Net gains (losses) on fair value hedging relationships
Interest contracts
Recognized on hedged items	(5		)	—			—		1			—
Recognized on derivatives designated as hedging instruments	(12		)	—			—		—			—
Net income (expense) recognized on fair value hedges	(17		)	—			—		1			—
Net gain (loss) on cash flow hedging relationships
Interest contracts
Realized gains (losses) (pre-tax) reclassified from AOCI into net income	(2		)	(68		)	2		—			31
Net income (expense) recognized on cash flow hedges	$	(2	)	$	(68	)	$	2	—			31
Year ended December 31, 2017
Total amounts presented in the consolidated statement of income	$	(319	)	$	3,677		$	603	$	(278	)	$	153
Net gains (losses) on fair value hedging relationships
Interest contracts
Recognized on hedged items	—			—			—		—			107
Recognized on derivatives designated as hedging instruments	49			—			—		—			(103		)
Net income (expense) recognized on fair value hedges	$	49		—			—		—			$	4
Net gain (loss) on cash flow hedging relationships
Interest contracts
Realized gains (losses) (pre-tax) reclassified from AOCI into net income	$	(4	)	$	19		—		—			—
Gains (losses) (before tax) recognized in income for hedge ineffectiveness	—			—			—		—			—
Net income (expense) recognized on cash flow hedges	$	(4	)	$	19		$	—	—			—
Year ended December 31, 2016
Total amounts presented in the consolidated statement of income	$	(218	)	$	2,773		$	482	$	(171	)	$	114
Net gains (losses) on fair value hedging relationships
Interest contracts
Recognized on hedged items	—			—			—		—			97
Recognized on derivatives designated as hedging instruments	96			—			—		—			(95		)
Net income (expense) recognized on fair value hedges	96			—			—		—			2
Net gain (loss) on cash flow hedging relationships
Interest contracts
Realized gains (losses) (pre-tax) reclassified from AOCI into net income	(4		)	85			—		—			—
Gains (losses) (before tax) recognized in income for hedge ineffectiveness	—			—			—		—			—
Net income (expense) recognized on cash flow hedges	$	(4	)	$	85		$	—	—			—

(a) Prior period gain or loss amounts were not restated to conform to the new hedge accounting guidance adopted in 2018.

Net investment hedges. We enter into foreign currency forward contracts to hedge our exposure to changes in the carrying value of our investments as a result of changes in the related foreign exchange rates. At December 31, 2018, AOCI reflected unrecognized after-tax gains totaling $27 million related to cumulative changes in the fair value of our net investment hedges, which offset the unrecognized after-tax foreign currency losses on net investment balances. We did not exclude any portion of our hedging instruments from the assessment of hedge effectiveness during the year ended December 31, 2018.

The following table summarizes the pre-tax net gains (losses) on our cash flow and net investment hedges for the years ended December 31, 2018, December 31, 2017, and December 31, 2016, and where they are recorded on the income statement. The table includes net gains (losses) recognized in OCI during the period and net gains (losses) reclassified from OCI into income during the current period.

in millions	Net Gains (Losses) Recognized in OCI			Income Statement Location of Net Gains (Losses) Reclassified From OCI Into Income	Net Gains (Losses) Reclassified From OCI Into Income(a)			Net Gains (Losses) Recognized in Other Income(a)
Year ended December 31, 2018
Cash Flow Hedges
Interest rate	$	(13	)	Interest income — Loans	$	(68	)	$	—
Interest rate	2			Interest expense — Long-term debt	(2		)	—
Interest rate	1			Investment banking and debt placement fees	2			—
Net Investment Hedges
Foreign exchange contracts	19			Other Income	31			—
Total	$	9			$	(37	)	$	—
Year ended December 31, 2017
Cash Flow Hedges
Interest rate	$	(59	)	Interest income — Loans	$	19		$	—
Interest rate	—			Interest expense — Long-term debt	(4		)	—
Interest rate	(1		)	Investment banking and debt placement fees	—			—
Net Investment Hedges
Foreign exchange contracts	(17		)	Other Income	—			—
Total	$	(77	)		$	15		$	—
Year ended December 31, 2016
Cash Flow Hedges
Interest rate	$	29		Interest income — Loans	$	85		$	—
Interest rate	—			Interest expense — Long-term debt	(4		)	—
Interest rate	1			Investment banking and debt placement fees	—			—
Net Investment Hedges
Foreign exchange contracts	(2		)	Other Income	—			—
Total	$	28			$	81		$	—

(a) Prior period gain or loss amounts were not restated to conform to the new hedge accounting guidance adopted in 2018.

Nonhedging instruments.

The following table summarizes the pre-tax net gains (losses) on our derivatives that are not designated as hedging instruments for the years ended December 31, 2018, December 31, 2017, and December 31, 2016, and where they are recorded on the income statement.

	2018											2017											2016
Year ended December 31, in millions	Corporate Services Income		Consumer Mortgage Income			Other Income			Total			Corporate Services Income		Consumer Mortgage Income			Other Income			Total			Corporate Services Income		Consumer Mortgage Income		Other Income			Total
NET GAINS (LOSSES)
Interest rate	$	38	—			$	(1	)	$	37		$	29	—			$	(1	)	$	28		$	30	—		$	1		$	31
Foreign exchange	42		—			—			42			41		—			—			41			40		—		—			40
Commodity	8		—			—			8			6		—			—			6			4		—		—			4
Credit	2		—			(30		)	(28		)	2		—			(21		)	(19		)	1		—		(16		)	(15		)
Other	—		$	(1	)	12			11			—		$	(1	)	(6		)	(7		)	—		$	1	—			1
Total net gains (losses)	$	90	$	(1	)	$	(19	)	$	70		$	78	$	(1	)	$	(28	)	$	49		$	75	$	1	$	(15	)	$	61

Counterparty Credit Risk

We use several means to mitigate and manage exposure to credit risk on derivative contracts. We enter into bilateral collateral and master netting agreements that provide for the net settlement of all contracts with a single counterparty in the event of default. Additionally, we monitor counterparty credit risk exposure on each contract to determine appropriate limits on our total credit exposure across all product types. We review our collateral positions on a daily basis and exchange collateral with our counterparties in accordance with standard ISDA documentation, central clearing rules, and other related agreements. We hold collateral in the form of cash and highly rated securities issued by the U.S. Treasury, government-sponsored enterprises, or GNMA. Cash collateral netted against derivative assets on the balance sheet totaled $33 million at December 31, 2018, and $23 million at December 31, 2017. The cash collateral netted against derivative liabilities totaled $37 million at December 31, 2018, and $150 million at December 31, 2017.

The following table summarizes the fair value of our derivative assets by type at the dates indicated. These assets represent our gross exposure to potential loss after taking into account the effects of bilateral collateral and master netting agreements and other means used to mitigate risk.

December 31, in millions	2018		2017
Interest rate	$	308	$	401
Foreign exchange	60		77
Commodity	187		163
Credit	—		1
Other	9		4
Derivative assets before collateral	564		646
Less: Related collateral	33		(23		)
Total derivative assets	$	531	$	669

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. These types of transactions are primarily high dollar volume. We enter into bilateral collateral and master netting agreements with these counterparties. We clear certain types of derivative transactions with these counterparties, whereby central clearing organizations become the counterparties to our derivative contracts. In addition, we enter into derivative contracts through swap execution facilities. Swap clearing and swap execution facilities reduce our exposure to counterparty credit risk. At December 31, 2018, we had gross exposure of $382 million to broker-dealers and banks. We had net exposure of $241 million after the application of master netting agreements and cash collateral, where such qualifying agreements exist. We had net exposure of $237 million after considering $4 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 primarily low dollar volume. We enter into master netting agreements with these counterparties. In addition, we mitigate our overall portfolio exposure and market risk by buying and selling U.S. Treasuries and Eurodollar futures and entering into offsetting positions and other derivative contracts, sometimes with entities other than broker-dealers and banks. Due to the smaller size and magnitude of the individual contracts with clients, we typically do not exchange collateral in connection with these derivative transactions. To address the risk of default associated with the uncollateralized contracts, we have established a credit valuation adjustment (included in “accrued income and other assets”) in the amount of $4 million at December 31, 2018, which we estimate to be the potential future losses on amounts due from client counterparties in the event of default. At December 31, 2018, we had gross exposure of $345 million to client counterparties and other entities that are not broker-dealers or banks for derivatives that have associated master netting agreements. We had net exposure of $290 million on our derivatives with these counterparties after the application of master netting agreements, collateral, and the related reserve.

Credit Derivatives

We are a buyer and, under limited circumstances, may be a 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 as well as exposures to debt securities. Our credit derivative portfolio was in a net liability position of less than $1 million as of December 31, 2018 and $3 million as of December 31, 2017.

Our credit derivative portfolio consists of the following:

• Single-name credit default swap: A bilateral contract whereby the seller agrees, for a premium, to provide protection against the credit risk of a specific entity (the “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, identified in the credit derivative contract.

• Traded credit default swap index: Represents a position on a basket or portfolio of reference entities.

• Risk participation agreement: A transaction in which 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. If the customer defaults on the swap contract and the seller fulfills its payment obligations under the risk participation agreement, the seller is entitled to a pro rata share of the lead participant’s claims against the customer under the terms of the swap agreement.

The following table provides information on the types of credit derivatives sold by us and held on the balance sheet at December 31, 2018, and December 31, 2017. The notional amount represents the maximum amount that the seller could be required to pay. The payment/performance risk assessment is based on the default probabilities for the underlying reference entities’ debt obligations using a Moody’s credit ratings matrix known as Moody’s “Idealized” Cumulative Default Rates. The payment/performance risk shown in the table represents a weighted-average of the default probabilities for all reference entities in the respective portfolios. These default probabilities are directly correlated to the probability that we will have to make a payment under the credit derivative contracts.

 

	2018					2017
December 31, dollars in millions	Notional Amount		Average Term (Years)	Payment / Performance Risk		Notional Amount		Average Term (Years)	Payment / Performance Risk
Other	$	22	13.43	17.18	%	$	15	3.08	6.64	%
Total credit derivatives sold	$	22	—	—		$	15	—	—

Credit Risk Contingent Features

We have entered into certain derivative contracts that require us to post collateral to the counterparties when these contracts are in a net liability position. The amount of collateral to be posted is based on the amount of the net liability and thresholds generally related to our long-term senior unsecured credit ratings with Moody’s and S&P. Collateral requirements also are based on minimum transfer amounts, which are specific to each Credit Support Annex (a component of the ISDA Master Agreement) that we have signed with the counterparties. In a limited number of instances, counterparties have the right to terminate their ISDA Master Agreements with us if our ratings fall below a certain level, usually investment-grade level (i.e., “Baa3” for Moody’s and “BBB-” for S&P). At December 31, 2018, KeyBank’s rating was “A3” with Moody’s and “A-” with S&P, and KeyCorp’s rating was “Baa1” with Moody’s and “BBB+” with S&P. As of December 31, 2018, the aggregate fair value of all derivative contracts with credit risk contingent features (i.e., those containing collateral posting or termination provisions based on our ratings) held by KeyBank that were in a net liability position totaled $66 million, which includes $80 million in derivative assets and $146 million in derivative liabilities. We had $55 million in cash and securities collateral posted to cover those positions as of December 31, 2018. There were no derivative contracts with credit risk contingent features held by KeyCorp at December 31, 2018.

The following table summarizes the additional cash and securities collateral that KeyBank would have been required to deliver under the ISDA Master Agreements had the credit risk contingent features been triggered for the derivative contracts in a net liability position as of December 31, 2018, and December 31, 2017. The additional collateral amounts were calculated based on scenarios under which KeyBank’s ratings are downgraded one, two, or three ratings as of December 31, 2018, and December 31, 2017, and take into account all collateral already posted. A similar calculation was performed for KeyCorp, and no additional collateral would have been required at December 31, 2018, or December 31, 2017.

December 31, in millions	2018				2017
	Moody’s		S&P		Moody’s		S&P
KeyBank’s long-term senior unsecured credit ratings	A3		A-		A3		A-
One rating downgrade	$	2	$	2	$	2	$	2
Two rating downgrades	2		2		2		2
Three rating downgrades	2		2		2		2

KeyBank’s long-term senior unsecured credit rating was four ratings above noninvestment grade at Moody’s and S&P as of December 31, 2018, and December 31, 2017. If KeyBank’s ratings had been downgraded below investment grade as of December 31, 2018, and December 31, 2017, payments of up to $4 million and $12 million, respectively, would have been required to either terminate the contracts or post additional collateral for those contracts in a net liability position, taking into account all collateral already posted. If KeyCorp’s ratings had been downgraded below investment grade as of December 31, 2018, and December 31, 2017, no payments would have

been required to either terminate the contracts or post additional collateral for those contracts in a net liability position, taking into account all collateral already posted.