14. Acquisition, Divestiture, and Discontinued Operations

Acquisition

First Niagara Financial Group, Inc. As previously disclosed, on October 30, 2015, KeyCorp entered into a definitive agreement and plan of merger (“Agreement”) to acquire all of the outstanding capital stock of First Niagara, headquartered in Buffalo, New York. On August 1, 2016, First Niagara merged with and into KeyCorp, with KeyCorp as the surviving entity. The total consideration for the transaction was approximately $4.0 billion. Under the terms of the Agreement, at the effective time of the merger, each share of First Niagara common stock was converted into the right to receive (i) 0.680 of a share of KeyCorp common stock and (ii) $2.30 in cash. The exchange ratio of KeyCorp stock for First Niagara stock was fixed per the Agreement and did not adjust based on changes in KeyCorp’s share trading price. First Niagara equity awards outstanding immediately prior to the effective time of the merger were converted into equity awards for KeyCorp common stock as provided in the Agreement. Each share of First Niagara’s Fixed-to-Floating Rate Perpetual Non-Cumulative Preferred Stock, Series B, was converted into a share of a newly created series of preferred stock of KeyCorp having substantially the same terms as First Niagara’s preferred stock. For more information on the acquisition, see Note 2 (“Business Combination”).

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.

Divestiture

On September 9, 2016, KeyCorp sold to Northwest Bank, a wholly-owned subsidiary of Northwest Bancshares, Inc., 18 branches in the Buffalo, New York market. The branches were divested in connection with the merger between First Niagara and KeyCorp and pursuant to an agreement with the United States Department of Justice and commitments to the Board of Governors of the Federal Reserve System following a customary antitrust review in connection with the merger. The divestiture included $439 million of loans and $1.6 billion of deposits associated with the 18 branches.

Discontinued operations

Education lending. In September 2009, we decided to exit the government-guaranteed education lending business. As a result, we have accounted for this business as a discontinued operation.

As of January 1, 2010, we consolidated our 10 outstanding education lending securitization trusts since we held the residual interests and are the master servicer with the power to direct the activities that most significantly influence the economic performance of the trusts.

On September 30, 2014, we sold the residual interests in all of our outstanding education lending securitization trusts to a third party for $57 million. In selling the residual interests, we no longer have the obligation to absorb losses or the right to receive benefits related to the securitization trusts. Therefore, in accordance with the applicable accounting guidance, we deconsolidated the securitization trusts and removed trust assets of $1.7 billion and trust liabilities of $1.6 billion from our balance sheet at September 30, 2014. As part of the sale and deconsolidation, we recognized an after-tax loss of $25 million, which was recorded in “income (loss) from discontinued operations, net of tax” on our income statement. We continue to service the securitized loans in eight of the securitization trusts and receive servicing fees, whereby we are adequately compensated, as well as remain a counterparty to derivative contracts with three of the securitization trusts. We retained interests in the securitization trusts through our ownership of an insignificant percentage of certificates in two of the securitization trusts and two interest-only strips in one of the securitization trusts. These retained interests were remeasured at fair value on September 30, 2014, and their fair value of $1 million was recorded in “discontinued assets” on our balance sheet. These assets were valued using a similar approach and inputs that have been used to value the education loan securitization trust loans and securities, which are further discussed later in this note.

“Income (loss) from discontinued operations, net of taxes” on the income statement includes (i) the changes in fair value of the assets and liabilities of the education loan securitization trusts, the loans at fair value in portfolio, and the loans held for sale at fair value in portfolio (discussed later in this note), and (ii) the interest income and expense from the loans and the securities of the trusts, the loans in portfolio, and the loans held for sale in portfolio at both amortized cost and fair value. These amounts are shown separately in the following table. Gains and losses attributable to changes in fair value are recorded as a component of “noninterest income” or “noninterest expense.” Interest income and interest expense related to the loans and securities are included as components of “net interest income.”

The components of “income (loss) from discontinued operations, net of taxes” for the education lending business are as follows:



Year ended December 31, in millions	2016		2015		2014
Net interest income	$	26	$	36	$	77
Provision for credit losses	13		21		21
Net interest income after provision for credit losses	13		15		56
Noninterest income	6		4		(111		)
Noninterest expense	17		17		24
Income (loss) before income taxes	2		2		(79		)
Income taxes	1		1		(30		)
Income (loss) from discontinued operations, net of taxes ^(a)	$	1	$	1	$	(49	)


(a)	Includes after-tax charges of $24 million, $23 million, and $32 million for the years ended December 31, 2016, December 31, 2015, and December 31, 2014, respectively, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support the discontinued operations.

The discontinued assets of our education lending business included on the balance sheet are as follows. There were no discontinued liabilities for the periods presented below.



December 31, in millions	2016		2015
Held-to-maturity securities	$	1	$	1
Portfolio loans at fair value	3		4
Loans, net of unearned income ^(a)	1,562		1,824
Less: Allowance for loan and lease losses	24		28
Net loans	1,541		1,800
Accrued income and other assets	28		30
Total assets	$	1,570	$	1,831


(a)	At December 31, 2016, and December 31, 2015, unearned income was less than $1 million.

The discontinued education lending business consisted of loans in portfolio (recorded at fair value) and loans in portfolio (recorded at carrying value with appropriate valuation reserves). As of June 30, 2015, we decided to sell the portfolio loans that were recorded at fair value, which were subsequently sold during the fourth quarter of 2015. The assets and liabilities in the securitization trusts (recorded at fair value) were removed with the deconsolidation of the securitization trusts on September 30, 2014.

At December 31, 2016, education loans included 2,163 TDRs with a recorded investment of approximately $22 million (pre-modification and post-modification). A specifically allocated allowance of $2 million was assigned to these loans as of December 31, 2016. At December 31, 2015, education loans included 1,901 TDRs with a recorded investment of approximately $21 million (pre-modification and post-modification). A specifically allocated allowance of $2 million was assigned to these loans as of December 31, 2015. At December 31, 2014, education loans included 1,612 TDRs with a recorded investment of approximately $17 million (pre-modification and post-modification). A specifically allocated allowance of $1 million was assigned to these loans at December 31, 2014. There have been no significant payment defaults. There are no significant commitments outstanding to lend additional funds to these borrowers. Additional information regarding TDR classification and ALLL methodology is provided in Note 6 (“Asset Quality”).

On June 27, 2014, we purchased the private loans from one of the education loan securitization trusts through the execution of a clean-up call option. The trust used the cash proceeds from the sale of these loans to retire the outstanding securities related to these private loans, and there are no future commitments or obligations to the holders of the securities. The portfolio loans were valued using an internal discounted cash flow method, which was affected by assumptions for defaults, expected credit losses, discount rates, and prepayments. The portfolio loans are considered to be Level 3 assets since we rely on unobservable inputs when determining fair value.

In June 2015, we transferred $179 million of loans that were previously purchased from three of the outstanding securitization trusts pursuant to the legal terms of those particular trusts to held for sale and accounted for them at fair value. These portfolio loans held for sale were valued based on indicative bids to sell the loans. These portfolio loans were previously valued using an internal discounted cash flow model, which was affected by assumptions for defaults, loss severity, discount rates, and prepayments. These loans were considered Level 3 assets since we relied on unobservable inputs when determining their fair value. Our valuation process for these loans prior to June 2015, as well as the trust loans and securities prior to the sale of the residual interests in September 2014, is discussed in more detail below. On October 29, 2015, government-guaranteed loans were sold for $117 million. On December 8, 2015, private loans were sold for $45 million. The gain on the sale of these loans was $1 million. The remaining portfolio loans held for sale, totaling $4 million, were reclassified to portfolio loans at fair value at December 31, 2015. Portfolio loans accounted for at fair value were $3 million at December 31, 2016.

When we first consolidated the education loan securitization trusts, we made an election to record them at fair value. Carrying the assets and liabilities of the trusts at fair value better depicted our economic interest. The fair value of the assets and liabilities of the trusts was determined by calculating the present value of the future expected cash flows. We relied on unobservable inputs (Level 3) when determining the fair value of the assets and liabilities of the trusts because observable market data was not available. Our valuation process is described in more detail below.

Corporate Treasury, within our Finance area, was responsible for the quarterly valuation process that previously determined the fair value of our student loans held in portfolio that were accounted for at fair value and for our loans and securities in our education loan securitization trusts. Corporate Treasury provided these fair values to a Working Group Committee (the “Working Group”) comprising representatives from the line of business, Credit and Market Risk Management, Accounting, Business Finance (part of our Finance area), and Corporate Treasury. The Working Group is a subcommittee of the Fair Value Committee that is discussed in more detail in Note 7 (“Fair Value Measurements”). The Working Group reviewed all significant inputs and assumptions and approved the resulting fair values.

The Working Group reviewed actual performance trends of the loans on a quarterly basis and used statistical analysis and

qualitative measures to determine assumptions for future performance. Predictive models that incorporate delinquency and

charge-off trends along with economic outlooks assisted the Working Group to forecast future defaults. The Working Group

used this information to formulate the credit outlook related to the loans. Higher projected defaults, fewer expected recoveries,

elevated prepayment speeds, and higher discount rates would be expected to result in a lower fair value of the portfolio

loans. Default expectations and discount rate changes had the most significant impact on the fair values of the loans. Increased

cash flow uncertainty, whether through higher defaults and prepayments or fewer recoveries, can result in higher discount rates

for use in the fair value process for these loans.

The valuation process for the portfolio loans that were accounted for at fair value was based on a discounted cash flow analysis

using a model purchased from a third party and maintained by Corporate Treasury. The valuation process began with loan-level

data that was aggregated into pools based on underlying loan structural characteristics (i.e., current unpaid principal balance,

contractual term, interest rate). Cash flows for these loan pools were developed using a financial model that reflected certain

assumptions for defaults, recoveries, status changes, and prepayments. A net earnings stream, taking into account cost of

funding, was calculated and discounted back to the measurement date using an appropriate discount rate. This resulting amount

was used to determine the present value of the loans, which represented their fair value to a market participant.

The unobservable inputs set forth in the following table were reviewed and approved by the Working Group on a quarterly

basis. As of December 31, 2015, the portfolio loans accounted for at fair value were valued based on the indicative bids we

received when we sold $162 million of these loans in late 2015.

A quarterly variance analysis reconciled valuation changes in the model used to calculate the portfolio loans accounted for at

fair value. This quarterly analysis considered loan run-off, yields, and future default and recovery changes. We also performed

back-testing to compare expected defaults to actual experience; the impact of future defaults could significantly affect the fair

value of these loans over time. In addition, our internal model validation group periodically performed a review to ensure the

accuracy and validity of the model for determining the fair value of these loans.

The following table shows the significant unobservable inputs used to measure the portfolio loans accounted for at fair value at December 31, 2016, and December 31, 2015.



December 31, 2016	Fair Value of Level 3 Assets and Liabilities		Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
dollars in millions	Fair Value of Level 3 Assets and Liabilities		Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
Portfolio loans accounted for at fair value	$	3	Market approach	Indicative bids	84.50-104.00%



December 31, 2015	Fair Value of Level 3 Assets and Liabilities		Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
dollars in millions	Fair Value of Level 3 Assets and Liabilities		Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
Portfolio loans accounted for at fair value	$	4	Market approach	Indicative bids	84.50-104.00%

The following table shows the principal and fair value amounts for our portfolio loans at carrying value and portfolio loans at fair value at December 31, 2016, and December 31, 2015. Our policies for determining past due loans, placing loans on nonaccrual, applying payments on nonaccrual loans, and resuming accrual of interest are disclosed in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Nonperforming Loans.”



in millions	December 31, 2016			December 31, 2015
	Principal		Fair Value	Principal		Fair Value
Portfolio loans at carrying value
Accruing loans past due 90 days or more	$	22	N/A	$	26	N/A
Loans placed on nonaccrual status	5		N/A	8		N/A
Portfolio loans at fair value
Accruing loans past due 90 days or more	—		—	$	1	$	1

The following table shows the portfolio loans at fair value and their related contractual amounts at December 31, 2016, and December 31, 2015.



in millions	December 31, 2016				December 31, 2015
in millions	Contractual Amount		Fair Value		Contractual Amount		Fair Value
ASSETS
Portfolio loans	$	3	$	3	$	4	$	4

The following tables present the assets of the portfolio loans measured at fair value on a recurring basis at December 31, 2016, and December 31, 2015.



December 31, 2016
in millions	Level 1	Level 2	Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans	—	—	$	3	$	3
Total assets on a recurring basis at fair value	—	—	$	3	$	3



December 31, 2015
in millions	Level 1	Level 2	Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans	—	—	$	4	$	4
Total assets on a recurring basis at fair value	—	—	$	4	$	4

The following table shows the change in the fair values of the Level 3 portfolio loans held for sale, portfolio loans, and consolidated education loan securitization trusts for the years ended December 31, 2016, and December 31, 2015.



in millions	Portfolio Student Loans Held For Sale			Portfolio Student Loans
Balance at December 31, 2014	—			$	191
Gains (losses) recognized in earnings ^(a)	$	(3	)	1
Sales	(161		)	—
Settlements	(11		)	(13		)
Loans transferred to held for sale	179			(179		)
Loans transferred to portfolio	(4		)	4
Balance at December 31, 2015 ^(b)	—			$	4
Settlements	—			(1		)
Balance at December 31, 2016 ^(b)	—			$	3


(a)	Gains (losses) were driven primarily by fair value adjustments.


(b)	There were no purchases, sales, issuances, gains (losses) recognized in earnings, transfers into Level 3, or transfers out of Level 3 for the years ended December 31, 2016 and December 31, 2015.

Victory Capital Management and Victory Capital Advisors. On July 31, 2013, we completed the sale of Victory to a private equity fund. During March 2014, client consents were secured and assets under management were finalized and, as a result, we recorded an additional after-tax cash gain of $6 million as of March 31, 2014. Since February 21, 2013, when we agreed to sell Victory, we have accounted for this business as a discontinued operation.

The results of this discontinued business are included in “income (loss) from discontinued operations, net of taxes” on the income statement. The components of “income (loss) from discontinued operations, net of taxes” for Victory, which includes the additional gain recorded as of March 31, 2014, on the sale of this business, are as follows:



Year ended December 31, in millions	2016	2015	2014
Net interest income	—	—	$	12
Noninterest income	—	—	10
Noninterest expense	—	—	1
Income (loss) before income taxes	—	—	21
Income taxes	—	—	8
Income (loss) from discontinued operations, net of taxes	—	—	$	13

There were no discontinued assets or liabilities of Victory for the years ended December 31, 2016, and December 31, 2015.

Austin Capital Management, Ltd. In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. As a result, we have accounted for this business as a discontinued operation.



Year ended December 31, in millions	2016	2015	2014
Noninterest expense	—	—	$	4
Income (loss) before income taxes	—	—	(4		)
Income taxes	—	—	(1		)
Income (loss) from discontinued operations, net of taxes	—	—	$	(3	)

The discontinued assets of Austin included on the balance sheet are as follows. There were no discontinued liabilities for the periods presented below.



December 31, in millions	2016		2015
Cash and due from banks	$	15	$	15
Total assets	$	15	$	15

Combined discontinued operations. The combined results of the discontinued operations are as follows:



Year ended December 31, in millions	2016		2015		2014
Net interest income	$	26	$	36	$	89
Provision for credit losses	13		21		21
Net interest income after provision for credit losses	13		15		68
Noninterest income	6		4		(101		)
Noninterest expense	17		17		29
Income (loss) before income taxes	2		2		(62		)
Income taxes	1		1		(23		)
Income (loss) from discontinued operations, net of taxes ^(a)	$	1	$	1	$	(39	)


(a)	Includes after-tax charges of $24 million, $23 million, and $32 million for the years ended December 31, 2016, December 31, 2015, and December 31, 2014, respectively, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support the discontinued operations.

The combined assets and liabilities of the discontinued operations are as follows:



December 31, in millions	2016		2015
Cash and due from banks	$	15	$	15
Held-to-maturity securities	1		1
Portfolio loans at fair value	3		4
Loans, net of unearned income ^(a)	1,562		1,824
Less: Allowance for loan and lease losses	24		28
Net loans	1,541		1,800
Accrued income and other assets	28		30
Total assets	$	1,585	$	1,846


(a)	At December 31, 2016, and December 31, 2015, unearned income was less than $1 million.