12. Acquisition, Divestiture, and Discontinued Operations

Acquisitions

Cain Brothers & Company, LLC. On August 15, 2017, KBCM entered into a definitive agreement with Cain Brothers & Company, Incorporated to acquire all of its right, title, and interests in Cain Brothers & Company, LLC (“Cain Brothers”), a healthcare-focused investment banking and public finance firm. This acquisition will expand KBCM’s investment banking group in the healthcare vertical by adding distinctive capabilities and broadening KBCM’s existing healthcare investment banking network. The acquisition, which will be accounted for as a business combination, closed on October 2, 2017. Accordingly, we will begin consolidating Cain Brothers’ financial results in our consolidated financial statements in the fourth quarter of 2017.

HelloWallet Holdings, Inc. On July 1, 2017, KeyBank acquired all of the outstanding capital stock of HelloWallet Holdings, Inc., the sole owner of HelloWallet, LLC, a digital financial wellness company. Key’s retail banking franchise is leveraging HelloWallet’s technology to provide data-driven insights to clients, allowing clients to better understand and improve their personal finances. The acquisition is accounted for as a business combination. During the third quarter of 2017, Key recognized provisional identifiable intangible assets with an estimated fair value of $12 million, comprised primarily of propriety software. Key also recognized provisional goodwill of $17 million in connection with this acquisition. These fair value estimates represent our best estimate of fair value and are expected to be finalized over a period of up to one year from the acquisition date.

Key Merchant Services, LLC. On June 30, 2017, KeyBank (consolidated) acquired an additional 51% interest in Key Merchant Services, LLC (“KMS”), increasing our ownership interest from 49% to 100%. This acquisition enables us to grow our merchant services business and enhance our merchant product offerings. This transaction is accounted for as a business combination achieved in stages. Prior to the acquisition, KMS was operated as a merchant services joint venture and accounted for as an equity method investment in our consolidated financial statements.

As of June 30, 2017, the provisional estimated fair value of our equity interest in KMS immediately before the acquisition was $74 million. The fair value of our previously held equity interest was measured using discounted cash flow modeling that incorporates an appropriate risk premium and forecast earnings information. On June 30, 2017, we recognized a provisional non-cash holding gain of $64 million for the difference between the fair value and the book value of our previously held equity interest. In the third quarter of 2017, we recognized a measurement-period adjustment of $5 million to reduce the provisional estimated fair value of our equity interest immediately before the acquisition to $69 million. The initial gain and subsequent adjustment were included in “other income” on the income statement for the nine months ended September 30, 2017. Upon acquisition, we recorded estimated identifiable intangible assets of $95 million and goodwill of less than $1 million. In the third quarter of 2017, we recognized a measurement-period adjustment of $10 million to reduce the fair value of acquired intangible assets to $85 million. In aggregate, the measurement-period adjustments recognized in the third quarter of 2017 increased goodwill recorded in connection with the KMS acquisition to $6 million. The fair value estimates related to this acquisition represent our best estimate of fair value and are expected to be finalized over a period of up to one year from the acquisition date.

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 First Niagara Bank 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 Federal Reserve 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 ten outstanding education lending securitization trusts, as 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 nor 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. 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 remaining 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 portfolio loans at fair value (discussed later in this note), and (ii) the interest income and expense from the loans 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:



	Three months ended September 30,				Nine months ended September 30,
in millions	2017		2016		2017		2016
Net interest income	$	6	$	6	$	17	$	20
Provision for credit losses	5		1		8		3
Net interest income after provision for credit losses	1		5		9		17
Noninterest income	1		1		4		4
Noninterest expense	1		4		4		13
Income (loss) before income taxes	1		2		9		8
Income taxes	—		1		3		3
Income (loss) from discontinued operations, net of taxes ^(a)	$	1	$	1	$	6	$	5

(a)

Includes after-tax charges of $5 million and $6 million for the three-month periods ended September 30, 2017, and September 30, 2016, respectively, and $18 million and $18 million for the nine-month periods ended September 30, 2017, and September 30, 2016, 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.



in millions	September 30, 2017		December 31, 2016
Held-to-maturity securities	$	1	$	1

Portfolio loans at fair value	2		3
Loans, net of unearned income ^(a)	1,370		1,562
Less: Allowance for loan and lease losses	18		24
Net loans	1,354		1,541

Accrued income and other assets	26		28
Total assets	$	1,381	$	1,570


(a)	At September 30, 2017, and December 31, 2016, 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.

At September 30, 2017, education loans included 2,655 TDRs with a recorded investment of approximately $26 million (pre-modification and post-modification). A specifically allocated allowance of $4 million was assigned to these loans as of September 30, 2017. 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. There have been no significant payment defaults. There are no significant commitments to lend additional funds to these borrowers outstanding. Additional information regarding TDR classification and ALLL methodology is provided in Note 5 (“Asset Quality”).

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 loans were considered Level 3 assets since we relied on unobservable inputs when determining their fair value. Portfolio loans accounted for at fair value were $2 million at September 30, 2017.

The following table shows the significant unobservable inputs used to measure the fair value of the portfolio loans accounted for at fair value as of September 30, 2017, and December 31, 2016:



September 30, 2017	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	$	2	Market approach	Indicative bids	84.50-104.00%



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%

The following table shows the principal and fair value amounts for our portfolio loans at carrying value at September 30, 2017, and December 31, 2016. 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” beginning on page 108 of our 2016 Form 10-K.



	September 30, 2017			December 31, 2016
in millions	Principal		Fair Value	Principal		Fair Value
Portfolio loans at carrying value
Accruing loans past due 90 days or more	$	18	N/A	$	22	N/A
Loans placed on nonaccrual status	8		N/A	5		N/A

The following table shows the portfolio loans at fair value and their related contractual amounts as of September 30, 2017, and December 31, 2016.



	September 30, 2017				December 31, 2016
in millions	Contractual Amount		Fair Value		Contractual Amount		Fair Value
ASSETS
Portfolio loans	$	2	$	2	$	3	$	3

At September 30, 2017, and December 31, 2016, portfolio loans measured at fair value on a recurring basis were $2 million and $3 million, respectively. These portfolio loans measured at fair value on a recurring basis are Level 3 assets. The following table shows the change in the fair values of the Level 3 portfolio loans, for the three- and nine-month periods ended September 30, 2017, and September 30, 2016.



in millions		Portfolio Student Loans
Balance at December 31, 2016		$	3
Settlements		(1		)
Balance at September 30, 2017	^(a)	$	2

Balance at June 30, 2017		$	2
Settlements		—
Balance at September 30, 2017	^(a)	$	2

Balance at December 31, 2015		$	4
Settlements		(1		)
Balance at September 30, 2016	^(a)	$	3

Balance at June 30, 2016		$	3
Settlements		—
Balance at September 30, 2016	^(a)	$	3


(a)	There were no purchases, sales, issuances, gains (losses) recognized in earnings, transfers into Level 3, or transfers out of Level 3 for the three- and nine-month periods ended September 30, 2017, and September 30, 2016.

Austin Capital Management, Ltd. In April 2009, we decided to discontinue 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. There was no income related to Austin for the nine-month periods ended September 30, 2017, and September 30, 2016. The discontinued assets of Austin consisted of cash and due from banks of $15 million at September 30, 2017, and December 31, 2016. There were no discontinued liabilities for the periods presented below.

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



	Three months ended September 30,				Nine months ended September 30,
in millions	2017		2016		2017		2016
Net interest income	$	6	$	6	$	17	$	20
Provision for credit losses	5		1		8		3
Net interest income after provision for credit losses	1		5		9		17
Noninterest income	1		1		4		4
Noninterest expense	1		4		4		13
Income (loss) before income taxes	1		2		9		8
Income taxes	—		1		3		3
Income (loss) from discontinued operations, net of taxes ^(a)	$	1	$	1	$	6	$	5

(a)

The combined assets of the discontinued operations are as follows. There were no discontinued liabilities for the periods presented below.



in millions	September 30, 2017		December 31, 2016
Cash and due from banks	$	15	$	15
Held-to-maturity securities	1		1

Portfolio loans at fair value	2		3
Loans, net of unearned income^(a)	1,370		1,562
Less: Allowance for loan and lease losses	18		24
Net loans	1,354		1,541

Accrued income and other assets	26		28
Total assets	$	1,396	$	1,585


(a)	At September 30, 2017, and December 31, 2016, unearned income was less than $1 million.