5. Fair Value Measurements

Fair Value Determination

As defined in the applicable accounting guidance, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants in our principal market. We have established and documented our process for determining the fair values of our assets and liabilities, where applicable. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, we determine the fair value of our assets and liabilities using valuation models or third-party pricing services. Both of these approaches rely on market-based parameters, when available, such as interest rate yield curves, option volatilities, and credit spreads, or unobservable inputs. Unobservable inputs may be based on our judgment, assumptions, and estimates related to credit quality, liquidity, interest rates, and other relevant inputs.

Valuation adjustments, such as those pertaining to counterparty and our own credit quality and liquidity, may be necessary to ensure that assets and liabilities are recorded at fair value. Credit valuation adjustments are made when market pricing does not accurately reflect the counterparty’s or our own credit quality. We make liquidity valuation adjustments to the fair value of certain assets to reflect the uncertainty in the pricing and trading of the instruments when we are unable to observe recent market transactions for identical or similar instruments. Liquidity valuation adjustments are based on the following factors:

the amount of time since the last relevant valuation;

whether there is an actual trade or relevant external quote available at the measurement date; and

volatility associated with the primary pricing components.

We ensure that our fair value measurements are accurate and appropriate by relying upon various controls, including:

an independent review and approval of valuation models and assumptions;

recurring detailed reviews of profit and loss; and

a validation of valuation model components against benchmark data and similar products, where possible.

We recognize transfers between levels of the fair value hierarchy at the end of the reporting period. Quarterly, we review any changes to our valuation methodologies to ensure they are appropriate and justified, and refine our valuation methodologies if more market-based data becomes available. The Fair Value Committee, which is governed by ALCO, oversees the valuation process for all lines of business and support areas, as applicable. Various Working Groups that report to the Fair Value Committee analyze and approve the valuation methodologies used to fair value assets and liabilities managed within specific areas. The Working Groups are discussed in more detail in the qualitative disclosures within this footnote and in Note 11 (“Acquisitions and Discontinued Operations”). Formal documentation of the fair valuation methodologies is prepared by the lines of business and support areas as appropriate. The documentation details the asset or liability class and related general ledger accounts, valuation techniques, fair value hierarchy level, market participants, accounting methods, valuation methodology, group responsible for valuations, and valuation inputs.

Additional information regarding our accounting policies for determining fair value is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Fair Value Measurements” on page 122 of our 2012 Form 10-K.

Qualitative Disclosures of Valuation Techniques

Loans. Most loans recorded as trading account assets are valued based on market spreads for similar assets since they are actively traded. Therefore, these loans are classified as Level 2 because the fair value recorded is based on observable market data for similar assets.

Securities (trading and available for sale). We own several types of securities, requiring a range of valuation methods:

Securities are classified as Level 1 when quoted market prices are available in an active market for the identical securities. Level 1 instruments include exchange-traded equity securities.

Securities are classified as Level 2 if quoted prices for identical securities are not available, and fair value is determined using pricing models (either by a third-party pricing service or internally) or quoted prices of similar securities. These instruments include municipal bonds; bonds backed by the U.S. government; corporate bonds; certain mortgage-backed securities; securities issued by the U.S. Treasury; money markets; and certain agency and corporate CMOs. Inputs to the pricing models include actual trade data (i.e., spreads, credit ratings, and interest rates) for comparable assets, spread tables, matrices, high-grade scales, option-adjusted spreads, and standard inputs, such as yields, benchmark securities, bids, and offers.

Securities are classified as Level 3 when there is limited activity in the market for a particular instrument. In such cases, we use internal models based on certain assumptions to determine fair value. Level 3 instruments consist of certain commercial mortgage-backed securities. Our Real Estate Capital line of business is responsible for the valuation process for these commercial mortgage-backed securities, which is conducted on a quarterly basis. The methodology incorporates a loan-by-loan credit review in combination with discounting the risk-adjusted bond cash flows. A detailed credit review of the underlying loans involves a screening process using a multitude of filters to identify the highest risk loans associated with these commercial mortgage-backed securities. Each of the highest risk loans identified is re-underwritten and loan specific defaults and recoveries are assigned. A matrix approach is used to assign an expected default and recovery percentage for the loans that are not individually re-underwritten. Bond classes will then be run through a discounted cash flow analysis, taking into account the expected default and recovery percentages as well as discount rates developed by our Finance area. Inputs for the Level 3 internal models include expected cash flows from the underlying loans, which take into account expected default and recovery percentages, market research, and discount rates commensurate with current market conditions. Changes in the credit quality of the underlying loans or market discount rate would impact the value of the bonds. An increase in the underlying loan credit quality or decrease in the market discount rate would positively impact the bond value. A decrease in the underlying loan credit quality or increase in the market discount rate would negatively impact the bond value.

The fair values of our Level 2 securities available for sale are determined by a third-party pricing service. The valuations provided by the third-party pricing service are based on observable market inputs, which include benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers, and reference data obtained from market research publications. Inputs used by the third-party pricing service in valuing CMOs and other mortgage-backed securities also include new issue data, monthly payment information, whole loan collateral performance, and “To Be Announced” prices. In valuations of state and political subdivisions securities, inputs used by the third-party pricing service also include material event notices.

On a quarterly basis, we validate the pricing methodologies utilized by our third-party pricing service to ensure the fair value determination is consistent with the applicable accounting guidance and that our assets are properly classified in the fair value hierarchy. To perform this validation, we:

review documentation received from our third-party pricing service regarding the inputs used in their valuations and determine a level assessment for each category of securities;

substantiate actual inputs used for a sample of securities by comparing the actual inputs used by our third-party pricing service to comparable inputs for similar securities; and

substantiate the fair values determined for a sample of securities by comparing the fair values provided by our third-party pricing service to prices from other independent sources for the same and similar securities. We analyze variances and conduct additional research with our third-party pricing service and take appropriate steps based on our findings.

Private equity and mezzanine investments. Private equity and mezzanine investments consist of investments in debt and equity securities through our Real Estate Capital line of business. They include direct investments made in specific properties, as well as indirect investments made in funds that pool assets of many investors to invest in properties. There is no active market for these investments, so we employ other valuation methods.

Private equity and mezzanine investments are classified as Level 3 assets since our judgment significantly influences the determination of fair value. Our Fund Management, Asset Management, and Accounting groups are responsible for reviewing the valuation models and determining the fair value of these investments on a quarterly basis. Direct investments in properties are initially valued based upon the transaction price. This amount is then adjusted to fair value based on current market conditions using the discounted cash flow method based on the expected investment exit date. The fair values of the assets are reviewed and adjusted quarterly. Periodically, a third-party appraisal is obtained for the investment to validate the specific inputs for determining fair value.

Inputs used in calculating future cash flows include the cost of build-out, future selling prices, current market outlook, and operating performance of the investment. Investment income and expense assumptions are based on market inputs, such as rental/leasing rates and vacancy rates for the geographic- and property type-specific markets. For investments under construction, investment income and expense assumptions are determined using expected future build-out costs and anticipated future rental prices based on current market conditions, discount rates, holding period, the terminal cap rate and sales commissions paid in the terminal cap year. For investments that are in lease-up or are fully leased, income and expense assumptions are based on the current geographic market lease rates, underwritten expenses, market lease terms, and historical vacancy rates. Asset Management validates these inputs on a quarterly basis through the use of industry publications, third-party broker opinions, and comparable property sales, where applicable. Changes in the significant inputs (rental/leasing rates, vacancy rates, valuation capitalization rate, discount rate, and terminal cap rate) would significantly affect the fair value measurement. Increases in rental/leasing rates would increase fair value while increases in the vacancy rates, the valuation capitalization rate, the discount rate, and the terminal cap rate would decrease fair value.

Indirect investments are valued using a methodology that is consistent with accounting guidance that allows us to use statements from the investment manager to calculate net asset value per share. A primary input used in estimating fair value is the most recent value of the capital accounts as reported by the general partners of the funds in which we invest. The calculation to determine the investment’s fair value is based on our percentage ownership in the fund multiplied by the net asset value of the fund, as provided by the fund manager.

Investments in real estate private equity funds are included within private equity and mezzanine investments. The main purpose of these funds is to acquire a portfolio of real estate investments that provides attractive risk-adjusted returns and current income for investors. Certain of these investments do not have readily determinable fair values and represent our ownership interest in an entity that follows measurement principles under investment company accounting. The following table presents the fair value of our indirect investments and related unfunded commitments at June 30, 2013:


June 30, 2013 in millions	Fair Value		Unfunded Commitments

INVESTMENT TYPE
Passive funds ^(a)	$	14	$	1
Co-managed funds ^(b)		18		—

Total	$	32	$	1

(a)

We invest in passive funds, which are multi-investor private equity funds. These investments can never be redeemed. Instead, distributions are received through the liquidation of the underlying investments in the funds. Some funds have no restrictions on sale, while others require investors to remain in the fund until maturity. The funds will be liquidated over a period of one to seven years.

(b)

We are a manager or co-manager of these funds. These investments can never be redeemed. Instead, distributions are received through the liquidation of the underlying investments in the funds. In addition, we receive management fees. We can sell or transfer our interest in any of these funds with the written consent of a majority of the fund’s investors. In one instance, the other co-manager of the fund must consent to the sale or transfer of our interest in the fund. The funds will mature over a period of two to five years.

Principal investments. Principal investments consist of investments in equity and debt instruments made by our principal investing entities. They include direct investments (investments made in a particular company), as well as indirect investments (investments made through funds that include other investors).

Each investment is adjusted to fair value with any net realized or unrealized gain/loss recorded in the current period’s earnings. This process is a coordinated and documented effort by the Principal Investing Entities Deal Team (comprised of individuals from one of the independent investment managers who oversee these instruments), members of the Key Principal Partners (“KPP”) finance and accounting staff, a member of Key’s senior management team, and the Investment Committee (comprised of individuals from Key and one of the independent investment managers). This process involves an in-depth review of the condition of each investment depending on the type of investment.

Our direct investments include investments in debt and equity instruments of both private and public companies. When quoted prices are available in an active market for the identical direct investment, we use the quoted prices in the valuation process, and the related investments are classified as Level 1 assets. However, in most cases, quoted market prices are not available for our direct investments, and we must perform valuations using other methods. These direct investment valuations are an in-depth analysis of the condition of each investment and are based on the unique facts and circumstances related to each individual investment. There is a certain amount of subjectivity surrounding the valuation of these investments due to the combination of quantitative and qualitative factors that are used in the valuation models. Therefore, these direct investments are classified as Level 3 assets. The specific inputs used in the valuations of each type of direct investment are described below.

Interest-bearing securities (i.e., loans) are valued on a quarterly basis. Valuation adjustments are determined by the Principal Investing Entities Deal Team and are subject to approval by the Investment Committee. Valuations of debt instruments are based on the Principal Investing Entities Deal Team’s knowledge of the current financial status of the subject company, which is regularly monitored throughout the term of the investment. Significant unobservable inputs used in the valuations of these investments include the company’s payment history, adequacy of cash flows from operations, and current operating results, including market multiples, and historical and forecast earnings before interest, taxation, depreciation, and amortization. Inputs can also include the seniority of the debt, the nature of any pledged collateral, the extent to which the security interest is perfected and the net liquidation value of collateral.

Valuations of equity instruments of private companies, which are prepared on a quarterly basis, are based on current market conditions and the current financial status of each company. A valuation analysis is performed to value each investment that is reviewed by the Principal Investing Entities Deal Team Member as well as reviewed and approved by the Chief Administrative Officer of one of the independent investment managers. Significant unobservable inputs used in these valuations include adequacy of the company’s cash flows from operations, any significant change in the company’s performance since the prior valuation, and any significant equity issuances by the company. Equity instruments of public companies are valued using quoted prices in an active market for the identical security. If the instrument is restricted, the fair value is determined considering the number of shares traded daily, the number of the company’s total restricted shares, and price volatility.

Our indirect investments are classified as Level 3 assets since our significant inputs are not observable in the marketplace. Indirect investments include primary and secondary investments in private equity funds engaged mainly in venture- and growth-oriented investing. These investments do not have readily determinable fair values. Indirect investments are valued using a methodology that is consistent with accounting guidance that allows us to estimate fair value based upon net asset value per share (or its equivalent, such as member units or an ownership interest in partners’ capital to which a proportionate share of net assets is attributed). The significant unobservable input used in estimating fair value is primarily the most recent value of the capital accounts as reported by the general partners of the funds in which we invest.

For indirect investments, management makes adjustments as deemed appropriate to the net asset value and only if it is determined that the net asset value does not properly reflect fair value. In determining the need for an adjustment to net asset value, management performs an analysis of the private equity funds based on the independent fund manager’s valuations as well as management’s own judgment. Significant unobservable inputs used in these analyses include current fund financial information provided by the fund manager, an estimate of future proceeds expected to be received on the investment, and market multiples. Management also considers whether the independent fund manager adequately marks down an impaired investment, maintains financial statements in accordance with GAAP, or follows a practice of holding all investments at cost.

The fair value of our indirect investments and related unfunded commitments at June 30, 2013, was $426 million and $84 million, respectively. Our indirect investments consist of buyout, venture capital, and fund of funds. These investments can never be redeemed. Instead, distributions are received through the liquidation of the underlying investments of the fund. An investment in any one of these funds can be sold only with the approval of the fund’s general partners. We estimate that the underlying investments of the funds will be liquidated over a period of one to nine years.

Derivatives. Exchange-traded derivatives are valued using quoted prices and, therefore, are classified as Level 1 instruments. However, only a few types of derivatives are exchange-traded. The majority of our derivative positions are valued using internally developed models based on market convention that use observable market inputs, such as interest rate curves, yield curves, LIBOR and Overnight Index Swap (OIS) discount rates and curves, index pricing curves, foreign currency curves, and volatility surfaces (a three-dimensional graph of implied volatility against strike price and maturity). These derivative contracts, which are classified as Level 2 instruments, include interest rate swaps, certain options, cross currency swaps, and credit default swaps.

In addition, we have several customized derivative instruments and risk participations that are classified as Level 3 instruments. These derivative positions are valued using internally developed models, with inputs consisting of available market data, such as bond spreads and asset values, as well as unobservable internally-derived assumptions, such as loss probabilities and internal risk ratings of customers. These derivatives are priced monthly by our Market Risk Management group using a credit valuation adjustment methodology. Swap details with the customer and our related participation percentage, if applicable, are obtained from our derivatives accounting system, which is the system of record. Applicable customer rating information is obtained from the particular loan system and represents an unobservable input to this valuation process. Using these various inputs, a valuation of these Level 3 derivatives is performed using a model that was acquired from a third party. In summary, the fair value represents an estimate of the amount that the risk participation counterparty would need to pay/receive as of the measurement date based on the probability of customer default on the swap transaction and the fair value of the underlying customer swap. Therefore, a higher loss probability and a lower credit rating would negatively affect the fair value of the risk participations and a lower loss probability and higher credit rating would positively affect the fair value of the risk participations.

Market convention implies a credit rating of “AA” equivalent in the pricing of derivative contracts, which assumes all counterparties have the same creditworthiness. To reflect the actual exposure on our derivative contracts related to both counterparty and our own creditworthiness, we record a fair value adjustment in the form of a default reserve. The credit component is determined by individual counterparty based on the probability of default, and considers master netting and collateral agreements. The default reserve is classified as Level 3. Our Market Risk Management group is responsible for the valuation policies and procedure related to this default reserve. A weekly reconciliation process is performed to ensure that all applicable derivative positions are covered in the calculation, which includes transmitting customer exposures and reserve reports to trading management, derivative traders and marketers, derivatives middle office, and corporate accounting personnel. On a quarterly basis, Market Risk Management prepares the reserve calculation. A detailed reserve comparison with the previous quarter, an analysis for change in reserve, and a reserve forecast are provided by Market Risk Management to ensure that the default reserve recorded at period end is sufficient.

Other assets and liabilities. The value of our repurchase and reverse repurchase agreements, trade date receivables and payables, and short positions is driven by the valuation of the underlying securities. The underlying securities may include equity securities, which are valued using quoted market prices in an active market for identical securities, resulting in a Level 1 classification. If quoted prices for identical securities are not available, fair value is determined by using pricing models or quoted prices of similar securities, resulting in a Level 2 classification. For the interest rate-driven products, such as government bonds, U.S. Treasury bonds and other products backed by the U.S. government, inputs include spreads, credit ratings and interest rates. For the credit-driven products, such as corporate bonds and mortgage-backed securities, inputs include actual trade data for comparable assets, and bids and offers.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Certain assets and liabilities are measured at fair value on a recurring basis in accordance with GAAP. The following tables present these assets and liabilities at June 30, 2013, December 31, 2012 and June 30, 2012.


June 30, 2013 in millions	Level 1		Level 2		Level 3		Total

ASSETS MEASURED ON A RECURRING BASIS
Short-term investments:
Securities purchased under resale agreements		—	$	334		—	$	334
Trading account assets:
U.S. Treasury, agencies and corporations		—		375		—		375
States and political subdivisions		—		28		—		28
Collateralized mortgage obligations		—		38		—		38
Other mortgage-backed securities		—		67		—		67
Other securities	$	3		71		—		74

Total trading account securities		3		579		—		582
Commercial loans		—		10		—		10

Total trading account assets		3		589		—		592
Securities available for sale:
States and political subdivisions		—		44		—		44
Collateralized mortgage obligations		—		12,603		—		12,603
Other mortgage-backed securities		—		584		—		584
Other securities		22		—		—		22

Total securities available for sale		22		13,231		—		13,253
Other investments:
Principal investments:
Direct		—		—	$	186		186
Indirect		—		—		426		426

Total principal investments		—		—		612		612
Equity and mezzanine investments:
Direct		—		—		—		—
Indirect		—		—		32		32

Total equity and mezzanine investments		—		—		32		32

Total other investments		—		—		644		644
Derivative assets:
Interest rate		—		1,203		25		1,228
Foreign exchange		85		15		—		100
Energy and commodity		—		117		2		119
Credit		—		2		4		6
Equity		—		—		—		—

Derivative assets		85		1,337		31		1,453
Netting adjustments^(a)		—		—		—		(992)

Total derivative assets		85		1,337		31		461
Accrued income and other assets		7		34		—		41

Total assets on a recurring basis at fair value	$	117	$	15,525	$	675	$	15,325


LIABILITIES MEASURED ON A RECURRING BASIS
Federal funds purchased and securities sold under repurchase agreements:
Securities sold under repurchase agreements		—	$	351		—	$	351
Bank notes and other short-term borrowings:
Short positions	$	4		294		—		298
Derivative liabilities:
Interest rate		—		871		—		871
Foreign exchange		78		15		—		93
Energy and commodity		—		113	$	1		114
Credit		—		11		—		11
Equity		—		—		—		—

Derivative liabilities		78		1,010		1		1,089
Netting adjustments^(a)		—		—		—		(633)

Total derivative liabilities		78		1,010		1		456
Accrued expense and other liabilities		—		2		—		2

Total liabilities on a recurring basis at fair value	$	82	$	1,657	$	1	$	1,107

(a)

Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with applicable accounting guidance. The net basis takes into account the impact of bilateral collateral and 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 collateral. Total derivative assets and liabilities include these netting adjustments.


December 31, 2012 in millions	Level 1		Level 2		Level 3		Total

ASSETS MEASURED ON A RECURRING BASIS
Short term investments:
Securities purchased under resale agreements		—	$	271		—	$	271
Trading account assets:
U.S. Treasury, agencies and corporations		—		383		—		383
States and political subdivisions		—		21	$	3		24
Collateralized mortgage obligations		—		8		—		8
Other mortgage-backed securities		—		4		—		4
Other securities	$	2		175		—		177

Total trading account securities		2		591		3		596
Commercial loans		—		9		—		9

Total trading account assets		2		600		3		605
Securities available for sale:
States and political subdivisions		—		49		—		49
Collateralized mortgage obligations		—		11,464		—		11,464
Other mortgage-backed securities		—		538		—		538
Other securities		43		—		—		43

Total securities available for sale		43		12,051		—		12,094
Other investments:
Principal investments:
Direct		—		—		191		191
Indirect		—		—		436		436

Total principal investments		—		—		627		627
Equity and mezzanine investments:
Direct		—		—		—		—
Indirect		—		—		41		41

Total equity and mezzanine investments		—		—		41		41

Total other investments		—		—		668		668
Derivative assets:
Interest rate		—		1,705		19		1,724
Foreign exchange		54		21		—		75
Energy and commodity		—		154		2		156
Credit		—		3		5		8
Equity		—		—		—		—

Derivative assets		54		1,883		26		1,963
Netting adjustments ^(a)		—		—		—		(1,270)

Total derivative assets		54		1,883		26		693
Accrued income and other assets		—		3		—		3

Total assets on a recurring basis at fair value	$	99	$	14,808	$	697	$	14,334


LIABILITIES MEASURED ON A RECURRING BASIS
Federal funds purchased and securities sold under repurchase agreements:
Securities sold under repurchase agreements		—	$	228		—	$	228
Bank notes and other short-term borrowings:
Short positions		—		287		—		287
Derivative liabilities:
Interest rate		—		1,152		—		1,152
Foreign exchange	$	55		20		—		75
Energy and commodity		—		149	$	1		150
Credit		—		9		1		10
Equity		—		—		—		—

Derivative liabilities		55		1,330		2		1,387
Netting adjustments ^(a)		—		—		—		(803)

Total derivative liabilities		55		1,330		2		584
Accrued expense and other liabilities		—		49		—		49

Total liabilities on a recurring basis at fair value	$	55	$	1,894	$	2	$	1,148

(a)


June 30, 2012 in millions	Level 1		Level 2		Level 3		Total

ASSETS MEASURED ON A RECURRING BASIS
Short term investments:
Securities purchased under resale agreements		—	$	338		—	$	338
Trading account assets:
U.S. Treasury, agencies and corporations		—		438		—		438
States and political subdivisions		—		27	$	57		84
Collateralized mortgage obligations		—		16		—		16
Other mortgage-backed securities		—		100		1		101
Other securities	$	3		37		—		40

Total trading account securities		3		618		58		679
Commercial loans		—		—		—		—

Total trading account assets		3		618		58		679
Securities available for sale:
States and political subdivisions		—		56		—		56
Collateralized mortgage obligations		—		12,477		—		12,477
Other mortgage-backed securities		—		652		—		652
Other securities		20		—		—		20

Total securities available for sale		20		13,185		—		13,205
Other investments:
Principal investments:
Direct		11		—		231		242
Indirect		—		—		482		482

Total principal investments		11		—		713		724
Equity and mezzanine investments:
Direct		—		—		18		18
Indirect		—		—		43		43

Total equity and mezzanine investments		—		—		61		61

Total other investments		11		—		774		785
Derivative assets:
Interest rate		—		1,824		35		1,859
Foreign exchange		81		26		—		107
Energy and commodity		—		209		—		209
Credit		—		19		6		25
Equity		—		—		—		—

Derivative assets		81		2,078		41		2,200
Netting adjustments ^(a)		—		—		—		(1,382)

Total derivative assets		81		2,078		41		818
Accrued income and other assets		2		134		—		136

Total assets on a recurring basis at fair value	$	117	$	16,353	$	873	$	15,961


LIABILITIES MEASURED ON A RECURRING BASIS
Federal funds purchased and securities sold under repurchase agreements:
Securities sold under repurchase agreements		—	$	481		—	$	481
Bank notes and other short-term borrowings:
Short positions	$	3		360		—		363
Derivative liabilities:
Interest rate		—		1,310		—		1,310
Foreign exchange		81		24		—		105
Energy and commodity		—		203	$	1		204
Credit		—		23		1		24
Equity		—		—		—		—

Derivative liabilities		81		1,560		2		1,643
Netting adjustments ^(a)		—		—		—		(880)

Total derivative liabilities		81		1,560		2		763
Accrued expense and other liabilities		—		4		—		4

Total liabilities on a recurring basis at fair value	$	84	$	2,405	$	2	$	1,611

(a)

Changes in Level 3 Fair Value Measurements

The following table shows the change in the fair values of our Level 3 financial instruments for the three and six months ended June 30, 2013, and 2012. We mitigate the credit risk, interest rate risk, and risk of loss related to many of these Level 3 instruments by using securities and derivative positions classified as Level 1 or Level 2. Level 1 and Level 2 instruments are not included in the following table. Therefore, the gains or losses shown do not include the impact of our risk management activities.


in millions	Beginning of Period Balance		Gains (Losses) Included in Earnings			Purchases		Sales		Settlements		Transfers into Level 3		^(e)	Transfers out of Level 3		^(e)	End of Period Balance		^(g)	Unrealized Gains (Losses) Included in Earnings

Six months ended June 30, 2013

Trading account assets
Other mortgage-backed securities		—	$	4	^(b)		—	$	(4)		—		—			—			—			—
Other securities		—		3	^(b)		—		—	$	(3)		—			—			—		$	1	^(b)
State and political subdivisions	$	3		—			—		(3)		—		—			—			—			—

Other investments
Principal investments
Direct		191		(5)	^(c)	$	4		(4)		—		—			—		$	186			(11)	^(c)
Indirect		436		19	^(c)		11		(40)		—		—			—			426			4	^(c)
Equity and mezzanine investments
Direct		—		—			—		—		—		—			—			—			3	^(c)
Indirect		41		2	^(c)		—		—		(11)		—			—			32			2	^(c)

Derivative instruments^(a)
Interest rate		19		(3)	^(d)		—		(1)		—	$	39	^(f)	$	(29)	^(f)		25			—
Energy and commodity		1		—			—		—		—		—			—			1			—
Credit		4		(3)	^(d)		—		—		3		—			—			4			—

Three months ended June 30, 2013

Trading account assets
Other mortgage-backed securities		—		—			—		—		—		—			—			—			—
Other securities		—	$	2	^(b)		—		—	$	(2)		—			—			—			—
State and political subdivisions	$	3		—			—	$	(3)		—		—			—			—			—

Other investments
Principal investments
Direct		191		(1)	^(c)		—		(4)		—		—			—		$	186		$	(7)	^(c)
Indirect		435		7	^(c)	$	5		(21)		—		—			—			426			—
Equity and mezzanine investments
Direct		—		—			—		—		—		—			—			—			—
Indirect		39		2	^(c)		—		—		(9)		—			—			32			2	^(c)

Derivative instruments^(a)
Interest rate		27		—			—		—		—	$	25	^(f)	$	(27)	^(f)		25			—
Energy and commodity		4		(3)	^(d)		—		—		—		—			—			1			—
Credit		4		(2)	^(d)		—		—		2		—			—			4			—


in millions	Beginning of Period Balance		Gains (Losses) Included in Earnings			Purchases		Sales		Settlements		Transfers into Level 3		^(e)	Transfers out of Level 3		^(e)	End of Period Balance		^(g)	Unrealized Gains (Losses) Included in Earnings

Six months ended June 30, 2012

Trading account assets
Other mortgage-backed securities	$	35	$	2	^(b)		—	$	(32)		—		—		$	(4)		$	1			—
State and political subdivisions		—		(2)	^(b)		—		—	$	2	$	57			—			57		$	(2)	^(b)
Other investments
Principal investments
Direct		225		8	^(c)	$	10		(12)		—		—			—			231			8	^(c)
Indirect		473		43	^(c)		20		(54)		—		—			—			482			28	^(c)
Equity and mezzanine investments
Direct		15		3			—		—		—		—			—			18			10	^(c)
Indirect		36		6	^(c)		4		—		(3)	$	—			—			43			6	^(c)

Derivative instruments^(a)
Interest rate		38		(3)	^(d)		1		(1)		—		4			(4)			35			—
Energy and commodity		(1)		—			—		—		—		—			—			(1)			—
Credit		(21)		(7)	^(d)		—		—		33		—			—			5			—

Three months ended June 30, 2012

Trading account assets
Other mortgage-backed securities	$	1		—	^(b)		—		—		—		—			—		$	1			—
State and political subdivisions		—	$	(5)	^(b)		—		—	$	5	$	57			—			57		$	(5)	^(b)

Other investments
Principal investments
Direct		226		7	^(c)	$	9	$	(11)		—		—			—			231			7	^(c)
Indirect		485		20	^(c)		10		(33)		—		—			—			482			9	^(c)
Equity and mezzanine investments
Direct		15		3			—		—		—		—			—			18			4	^(c)
Indirect		42		5	^(c)		1		—		(2)		(3)			—			43			2	^(c)

Derivative instruments^(a)
Interest rate		36		2	^(d)		—		—		—		—		$	(3)			35			—
Energy and commodity		(1)		—			—		—		—		—			—			(1)			—
Credit		5		(2)	^(d)		—		—		2		—			—			5			—

(a)	Amounts represent Level 3 derivative assets less Level 3 derivative liabilities.

(b)	Realized and unrealized gains and losses on trading account assets are reported in “other income” on the income statement.

(c)	Realized and unrealized gains and losses on principal investments and private equity and mezzanine investments are reported in “net gains (losses) from principal investing” on the income statement.

(d)	Realized and unrealized gains and losses on derivative instruments are reported in “corporate services income” and “other income” on the income statement.

(e)	Our policy is to recognize transfers into and transfers out of Level 3 as of the end of the reporting period.

(f)

Transfers from Level 2 to Level 3 were the result of Level 3 unobservable inputs becoming significant to certain derivatives previously classified as Level 2. Transfers from Level 3 to Level 2 were the result of Level 3 unobservable inputs becoming less significant to certain derivatives previously classified as Level 3.

(g)	There were no issuances for the six-month periods ended June 30, 2013 and 2012.

Assets Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis in accordance with GAAP. The adjustments to fair value generally result from the application of accounting guidance that requires assets and liabilities to be recorded at the lower of cost or fair value, or assessed for impairment. The following table presents our assets measured at fair value on a nonrecurring basis at June 30, 2013, December 31, 2012, and June 30, 2012:


	June 30, 2013
in millions	Level 1		Level 2		Level 3		Total

ASSETS MEASURED ON A NONRECURRING BASIS
Impaired loans		—		—	$	22	$	22
Loans held for sale ^(a)		—		—		—		—
Accrued income and other assets		—		—		16		16

Total assets on a nonrecurring basis at fair value		—		—	$	38	$	38



	December 31, 2012
in millions	Level 1		Level 2		Level 3		Total

ASSETS MEASURED ON A NONRECURRING BASIS
Impaired loans		—		—	$	25	$	25
Loans held for sale		—		—		9		9
Accrued income and other assets		—	$	2		20		22

Total assets on a nonrecurring basis at fair value		—	$	2	$	54	$	56



	June 30, 2012
in millions	Level 1		Level 2		Level 3		Total

ASSETS MEASURED ON A NONRECURRING BASIS
Impaired loans		—		—	$	81	$	81
Loans held for sale		—		—		15		15
Accrued income and other assets		—	$	17		25		42

Total assets on a nonrecurring basis at fair value		—	$	17	$	121	$	138

(a)	During the first half of 2013, we transferred $2 million of commercial and consumer loans and leases from held-for-sale status to the held-to-maturity portfolio at their current fair value.

Impaired loans. We typically adjust the carrying amount of our impaired loans when there is evidence of probable loss and the expected fair value of the loan is less than its contractual amount. The amount of the impairment may be determined based on the estimated present value of future cash flows, the fair value of the underlying collateral, or the loan’s observable market price. Impaired loans with a specifically allocated allowance based on cash flow analysis or the value of the underlying collateral are classified as Level 3 assets, while those with a specifically allocated allowance based on an observable market price that reflects recent sale transactions for similar loans and collateral are classified as Level 2.

The evaluations for impairment are prepared by the responsible relationship managers in our Asset Recovery Group and are reviewed and approved by the Asset Recovery Group Executive. The Asset Recovery Group is part of the Risk Management Group and reports to our Chief Risk Officer. These evaluations are performed in conjunction with the quarterly ALLL process.

Subject loans are evaluated for impairment on a quarterly basis. Loans included in the previous quarter’s review are reevaluated and if their values are materially different from the prior quarter evaluation, the underlying information (loan balance and in most cases, collateral value) is compared. Material differences are evaluated for reasonableness, and discussions are held between the relationship managers and their senior managers to understand the difference and determine if any adjustment is necessary. The inputs are developed and substantiated on a quarterly basis, based on current borrower developments, market conditions and collateral values.

The following two internal methods are used to value impaired loans:

Cash flow analysis considers internally developed inputs, such as discount rates, default rates, costs of foreclosure and changes in collateral values.

The fair value of the collateral, which may take the form of real estate or personal property, is based on internal estimates, field observations and assessments provided by third-party appraisers. We perform or reaffirm appraisals of collateral-dependent impaired loans at least annually. Appraisals may occur more frequently if the most recent appraisal does not accurately reflect the current market, the debtor is seriously delinquent or chronically past due, or there has been a material deterioration in the performance of the project or condition of the property. Adjustments to outdated appraisals that result in an appraisal value less than the carrying amount of a collateral-dependent impaired loan are reflected in the ALLL.

Impairment valuations are back-tested each quarter, based on a look-back of actual incurred losses on closed deals previously evaluated for impairment. The overall percent variance of actual net charge-offs on closed deals as compared to the specific allocations on such deals is considered in determining each quarter’s specific allocations.

Loans held for sale. Through a quarterly analysis of our loan portfolios held for sale, which include both performing and nonperforming loans, we determined that adjustments were necessary to record some of the portfolios at the lower of cost or fair value in accordance with GAAP. There were no loans held for sale portfolios adjusted to fair value at June 30, 2013. Loans held for sale portfolios adjusted to fair value totaled $9 million at December 31, 2012, and $15 million at June 30, 2012.

Current market conditions, including updated collateral values, and reviews of our borrowers’ financial condition influenced the inputs used in our internal models and other valuation methodologies, resulting in these adjustments. The valuations are prepared by the responsible relationship managers or analysts in our Asset Recovery Group and are reviewed and approved by the Asset Recovery Group Executive. Actual gains or losses realized on the sale of various loans held for sale provide a back-testing mechanism for determining the appropriateness of our valuations of these loans held for sale that are adjusted to fair value.

Valuations of performing commercial mortgage and construction loans held for sale are conducted using internal models that rely on market data from sales or nonbinding bids on similar assets, including credit spreads, treasury rates, interest rate curves and risk profiles, as well as our own assumptions about the exit market for the loans and details about individual loans within the respective portfolios. Therefore, we have classified these loans as Level 3 assets. The inputs related to our assumptions and other internal loan data include changes in real estate values, costs of foreclosure, prepayment rates, default rates and discount rates.

Valuations of nonperforming commercial mortgage and construction loans held for sale are based on current agreements to sell the loans or approved discounted payoffs. If a negotiated value is not available, we use third-party appraisals, adjusted for current market conditions. Since valuations are based on unobservable data, these loans have been classified as Level 3 assets.

Direct financing leases and operating lease assets held for sale. Our Key Equipment Finance (KEF) Accounting and Capital Markets groups are responsible for the valuation policies and procedures related to these assets. The Managing Director of the KEF Capital Markets group reports to the President of our Equipment Finance line of business. A weekly report is distributed to both groups that lists all Equipment Finance deals booked in the warehouse portfolio. On a quarterly basis, the KEF Accounting group prepares a detailed held-for-sale roll-forward schedule that is reconciled to the general ledger and the above mentioned weekly report. KEF management uses the held-for-sale roll-forward schedule to determine if an impairment adjustment is necessary in accordance with lower of cost or fair value guidelines.

Valuations of direct financing leases and operating lease assets held for sale are performed using an internal model that relies on market data, such as swap rates and bond ratings, as well as our own assumptions about the exit market for the leases and details about the individual leases in the portfolio. The inputs based on our assumptions include changes in the value of leased items and internal credit ratings. These leases have been classified as Level 3 assets. Leases also may be valued using current nonbinding bids when they are available. These leases are classified as Level 2 assets. In a distressed market where market data is not available, an estimate of the fair value of the leased asset may be used to value the lease, resulting in a Level 3 classification. In an inactive market, the market value of the assets held for sale is determined as the present value of the future cash flows discounted at the current buy rate. KEF Accounting calculates an estimated fair value buy rate based on the credit premium inherent in the relevant bond index and the appropriate swap rate on the measurement date. The amount of the adjustment is calculated as book value minus the present value of future cash flows discounted at the calculated buy rate.

Goodwill and other intangible assets. On a quarterly basis, we review impairment indicators to determine whether we need to evaluate the carrying amount of the goodwill and other intangible assets assigned to Key Community Bank and Key Corporate Bank. We also perform an annual impairment test for goodwill. New accounting guidance that permits an entity to first assess qualitative factors to determine whether additional goodwill impairment testing is required became effective for us on January 1, 2012. We did not choose to utilize this qualitative assessment in our annual goodwill impairment testing performed during the fourth quarter of 2012. Fair value of our reporting units is determined using both an income approach (discounted cash flow method) and a market approach (using publicly traded company and recent transactions data), which are weighted equally.

Inputs used include market-available data, such as industry, historical and expected growth rates, and peer valuations, as well as internally driven inputs, such as forecasted earnings and market participant insights. Since this valuation relies on a significant number of unobservable inputs, we have classified goodwill as Level 3. We use a third party valuation services provider to perform the annual, and if necessary, any interim, Step 1 valuation process, and to perform a Step 2 analysis, if needed, on our reporting units. Annual and any interim valuations prepared by the third-party valuation services provider are reviewed by the appropriate individuals within Key to ensure that the assumptions used in preparing the analysis are appropriate and properly supported. For additional information on the results of recent goodwill impairment testing, see Note 10 (“Goodwill and Other Intangible Assets”) on page on 171 of our 2012 Form 10-K.

The fair value of other intangible assets is calculated using a cash flow approach. While the calculation to test for recoverability uses a number of assumptions that are based on current market conditions, the calculation is based primarily on unobservable assumptions. Accordingly, these assets are classified as Level 3. Our lines of business, with oversight from our Accounting group, are responsible for routinely, at least quarterly, assessing whether impairment indicators are present. All indicators that signal impairment may exist are appropriately considered in this analysis. An impairment loss is only recognized for a held and used long lived asset if the sum of its estimated future undiscounted cash flows used to test for recoverability is less than its carrying value.

Our primary assumptions include attrition rates, alternative costs of funds and rates paid on deposits. For additional information on the results of other intangible assets impairment testing, see Note 10 (“Goodwill and Other Intangible Assets”) on page on 171 of our 2012 Form 10-K.

Other assets. OREO and other repossessed properties are valued based on inputs such as appraisals and third-party price opinions, less estimated selling costs. Generally, we classify these assets as Level 3, but OREO and other repossessed properties for which we receive binding purchase agreements are classified as Level 2. Returned lease inventory is valued based on market data for similar assets and is classified as Level 2. Assets that are acquired through, or in lieu of, loan foreclosures are recorded initially as held for sale at fair value less estimated selling costs at the date of foreclosure. After foreclosure, valuations are updated periodically, and current market conditions may require the assets to be marked down further to a new cost basis.

Commercial Real Estate Valuation Process: When a loan is reclassified from loan status to OREO because we took possession of the collateral, the Asset Recovery Group Loan Officer, in consultation with our OREO group, obtains a broker price opinion or a third-party appraisal, which is used to establish the fair value of the underlying collateral. The determined fair value of the underlying collateral less estimated selling costs becomes the carrying value of the OREO asset. In addition to valuations from independent third party sources, our OREO group also writes down the carrying balance of OREO assets once a bona fide offer is contractually accepted, through execution of a Purchase and Sale Agreement, where the accepted price is lower than the current balance of the particular OREO asset. The fair value of OREO property is re-evaluated every 90 days and the OREO asset is adjusted as necessary.

Consumer Real Estate Valuation Process: The Asset Management team within our Risk Operations group is responsible for valuation policies and procedures in this area. The current vendor partner provides monthly reporting of all broker price opinion evaluations, appraisals and the monthly market plans. Market plans are reviewed monthly, and valuations are reviewed and tested monthly to ensure proper pricing has been established and guidelines are being met. Risk Operations Compliance validates and provides periodic testing of the valuation process. The Asset Management team reviews changes in fair value measurements. The current vendor partner managed brokers review pricing monthly, while third-party broker price opinions are reviewed every 90 days, and the fair value is written down based on changes to the valuation. External factors are documented and monitored as appropriate.

Mortgage servicing assets are valued based on inputs such as prepayment speeds, earn rates, credit default rates, discount rates and servicing advances. We classify these assets as Level 3. Additional information regarding the valuation of mortgage servicing assets is provided in Note 8 (“Mortgage Servicing Assets”).

Quantitative Information about Level 3 Fair Value Measurements

The range and weighted-average of the significant unobservable inputs used to fair value our material Level 3 recurring and nonrecurring assets at June 30, 2013, December 31, 2012, and June 30, 2012, along with the valuation techniques used, are shown in the following table:

June 30, 2013

dollars in millions

Fair Value of
Level 3 Assets

Valuation Technique

Significant

Unobservable Input

Range

(Weighted-Average)

Recurring

Other investments — principal investments — direct:

186

Individual analysis of the condition

of each investment

Debt instruments

EBITDA multiple

5.80 - 6.00% (6.00%)

Equity instruments of private companies

EBITDA multiple (where applicable)

4.50 - 6.00% (5.80%)

Revenue multiple (where applicable)

1.00 - 4.80% (4.30%)

Nonrecurring

Impaired loans

Fair value of underlying collateral

Discount

0.00 - 100.00% (34.00%)

Goodwill

979

Discounted cash flow and market data

Earnings multiple of peers

9.70 - 14.20 (11.25)

Equity multiple of peers

.95 - 1.17 (1.09)

Control premium

N/A (30.00%)

Weighted-average cost of capital

N/A (13.00%)

December 31, 2012

dollars in millions

Fair Value of
Level 3 Assets

Valuation Technique

Significant

Unobservable Input

Range

(Weighted-Average)

Recurring

Other investments — principal investments — direct:

181

Individual analysis of the condition

of each investment

Debt instruments

EBITDA multiple

5.50 - 6.00% (5.90%)

Equity instruments of private companies

EBITDA multiple (where applicable)

5.00 - 8.50% (6.10%)

Revenue multiple (where applicable)

0.30 - 5.70% (4.80%)

Nonrecurring

Impaired loans

Fair value of underlying collateral

Discount

0.00 - 100.00% (45.00%)

Goodwill

979

Discounted cash flow and market data

Earnings multiple of peers

9.70 - 14.20 (11.25)

Equity multiple of peers

.95 - 1.17 (1.09)

Control premium

N/A (30.00%)

Weighted-average cost of capital

N/A (13.00%)

June 30, 2012

dollars in millions

Fair Value of
Level 3 Assets

Valuation Technique

Significant

Unobservable Input

Range

(Weighted-Average)

Recurring

Other investments — principal investments — direct:

220

Individual analysis of the condition

of each investment

Debt instruments

EBITDA multiple

4.8 - 8.2% (6.1%)

Equity instruments of private companies

EBITDA multiple (where applicable)

5.50 - 12.00% (6.3%)

Revenue multiple (where applicable)

0.20 - 4.4% (2.8%)

Nonrecurring

Impaired loans

Fair value of underlying collateral

Discount

0.00 - 100.00% (32.00%)

Goodwill

917

Discounted cash flow and market data

Earnings multiple of peers

8.30 - 11.90 (10.01)

Equity multiple of peers

1.21 - 1.32 (1.27)

Control premium

N/A (32.00%)

Weighted-average cost of capital

N/A (15.00%)

Fair Value Disclosures of Financial Instruments

The levels in the fair value hierarchy ascribed to our financial instruments and the related carrying amounts at June 30, 2013, December 31, 2012, and June 30, 2012 are shown in the following table.


	June 30, 2013
			Fair Value
in millions	Carrying Amount		Level 1		Level 2		Level 3		Netting Adjustment			Total

ASSETS
Cash and short-term investments ^(a)	$	4,278	$	3,944	$	334		—		—		$	4,278
Trading account assets ^(e)		592		3		589		—		—			592
Securities available for sale ^(e)		13,253		22		13,231		—		—			13,253
Held-to-maturity securities ^(b)		4,750		—		4,716		—		—			4,716
Other investments ^(e)		1,037		—		393	$	644		—			1,037
Loans, net of allowance ^(c)		52,405		—		—		51,019		—			51,019
Loans held for sale ^(e)		402		—		—		402		—			402
Mortgage servicing assets ^(d)		330		—		—		387		—			387
Derivative assets ^(e)		461		85		1,337		31	$	(992)	^(f)		461

LIABILITIES
Deposits with no stated maturity ^(a)	$	60,170		—	$	60,170		—		—		$	60,170
Time deposits ^(d)		7,551		545		7,127		—		—			7,672
Short-term borrowings ^(a)		1,945	$	4		1,941		—		—			1,945
Long-term debt ^(d)		6,666		6,247		784		—		—			7,031
Derivative liabilities ^(e)		456		78		1,010	$	1	$	(633)	^(f)		456


	December 31, 2012
			Fair Value
in millions	Carrying Amount		Level 1		Level 2		Level 3		Netting Adjustment			Total

ASSETS
Cash and short-term investments ^(a)	$	4,525	$	4,254	$	271		—		—		$	4,525
Trading account assets ^(e)		605		2		600	$	3		—			605
Securities available for sale ^(e)		12,094		43		12,051		—		—			12,094
Held-to-maturity securities ^(b)		3,931		—		3,992		—		—			3,992
Other investments ^(e)		1,064		—		396		668		—			1,064
Loans, net of allowance ^(c)		51,934		—		—		51,046		—			51,046
Loans held for sale ^(e)		599		—		—		599		—			599
Mortgage servicing assets ^(d)		204		—		—		238		—			238
Derivative assets ^(e)		693		54		1,883		26	$	(1,270)	^(f)		693

LIABILITIES
Deposits with no stated maturity ^(a)	$	58,132		—	$	58,132		—		—		$	58,132
Time deposits ^(d)		7,861	$	408		7,612		—		—			8,020
Short-term borrowings ^(a)		1,896		—		1,896		—		—			1,896
Long-term debt ^(d)		6,847		2,807		4,585		—		—			7,392
Derivative liabilities ^(e)		584		54		1,331	$	2	$	(803)	^(f)		584


	June 30, 2012
			Fair Value
in millions	Carrying Amount		Level 1		Level 2		Level 3		Netting Adjustment			Total

ASSETS
Cash and short-term investments ^(a)	$	2,933	$	2,595	$	338		—		—		$	2,933
Trading account assets ^(e)		679		3		618	$	58		—			679
Securities available for sale ^(e)		13,205		20		13,185		—		—			13,205
Held-to-maturity securities ^(b)		4,352		—		4,396		—		—			4,396
Other investments ^(e)		1,186		11		401		774		—			1,186
Loans, net of allowance ^(c)		48,717		—		—		47,912		—			47,912
Loans held for sale ^(e)		656		—		—		656		—			656
Mortgage servicing assets ^(d)		186		—		—		237		—			237
Derivative assets ^(e)		818		81		2,078		41	$	(1,382)	^(f)		818

LIABILITIES
Deposits with no stated maturity ^(a)	$	52,495		—	$	52,495		—		—		$	52,495
Time deposits ^(d)		9,672	$	617		9,271		—		—			9,888
Short-term borrowings ^(a)		2,078		3		2,075		—		—			2,078
Long-term debt ^(d)		7,521		3,890		3,955		—		—			7,845
Derivative liabilities ^(e)		763		81		1,560	$	2	$	(880)	^(f)		763

Valuation Methods and Assumptions

(a)	Fair value equals or approximates carrying amount. The fair value of deposits with no stated maturity does not take into consideration the value ascribed to core deposit intangibles.

(b)

Fair values of held-to-maturity securities are determined by using models that are based on security-specific details, as well as relevant industry and economic factors. The most significant of these inputs are quoted market prices, interest rate spreads on relevant benchmark securities, and certain prepayment assumptions. We review the valuations derived from the models to ensure they are reasonable and consistent with the values placed on similar securities traded in the secondary markets.

(c)

The fair value of loans is based on the present value of the expected cash flows. The projected cash flows are based on the contractual terms of the loans, adjusted for prepayments and use of a discount rate based on the relative risk of the cash flows, taking into account the loan type, maturity of the loan, liquidity risk, servicing costs, and a required return on debt and capital. In addition, an incremental liquidity discount is applied to certain loans, using historical sales of loans during periods of similar economic conditions as a benchmark. The fair value of loans includes lease financing receivables at their aggregate carrying amount, which is equivalent to their fair value.

(d)	Fair values of mortgage servicing assets, time deposits and long-term debt are based on discounted cash flows utilizing relevant market inputs.

(e)	Information pertaining to our methodology for measuring the fair values of these assets and liabilities is included in the sections entitled “Qualitative Disclosures of Valuation Techniques” and “Assets Measured at Fair Value on a Nonrecurring Basis” in this note.

(f)

We use valuation methods based on exit market prices in accordance with applicable accounting guidance. We determine fair value based on assumptions pertaining to the factors a market participant would consider in valuing the asset. A substantial portion of our fair value adjustments are related to liquidity. During 2012 and through the first half of 2013, the fair values of our loan portfolios have improved, primarily due to increasing liquidity in the loan markets. If we were to use different assumptions, the fair values shown in the preceding table could change. If a nonexit price methodology were used for valuing our loan portfolio for continuing operations, it would result in a premium of 1.37%. Also, because the applicable accounting guidance for financial instruments excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, the fair value amounts shown in the table above do not, by themselves, represent the underlying value of our company as a whole.

Education lending business. The discontinued education lending business consists of assets and liabilities (recorded at fair value) in the securitization trusts, as well as loans in portfolio (recorded at fair value), and loans in portfolio (recorded at carrying value with appropriate valuation reserves) that are outside the trusts. All of these loans were excluded from the table above as follows:

Loans at carrying value, net of allowance, of $2.2 billion ($2.1 billion at fair value) at June 30, 2013, $2.6 billion ($2.3 billion at fair value) at December 31, 2012, and $2.8 billion ($2.4 billion at fair value) at June 30, 2012;

Portfolio loans at fair value of $151 million at June 30, 2013, $157 million at December 31, 2012, and $73 million at June 30, 2012;

Loans in the trusts at fair value of $2.3 billion at June 30, 2013, $2.4 billion at December 31, 2012, and $2.6 billion at June 30, 2012.

Securities issued by the education lending securitization trusts, which are the primary liabilities of the trusts, totaling $2.1 billion in fair value at June 30, 2013, $2.2 billion in fair value at December 31, 2012, and $2.4 billion in fair value at June 30, 2012 are also excluded from the above table.

These loans and securities are classified as Level 3 because we rely on unobservable inputs when determining fair value since observable market data is not available.

Residential real estate mortgage loans. Residential real estate mortgage loans with carrying amounts of $2.2 billion at June 30, 2013 and December 31, 2012, and $2 billion at June 30, 2012 are included in “Loans, net of allowance” in the above table.

Short-term financial instruments. For financial instruments with a remaining average life to maturity of less than six months, carrying amounts were used as an approximation of fair values.