5. Fair Value Measurements

Fair Value Determination

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 on unobservable inputs. Unobservable inputs may be based on our judgment, assumptions, and estimates related to credit quality, liquidity, interest rates, and other relevant inputs.

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. Various working groups that report to the Fair Value Committee analyze and approve the underlying assumptions and valuation adjustments. Changes in valuation methodologies for Level 1 and Level 2 instruments are presented to the Accounting Policy group for approval. Changes in valuation methodologies for Level 3 instruments are presented to the Fair Value Committee for approval. The working groups are discussed in more detail in the qualitative disclosures within this note. 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.”

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, agency residential and CMBS, securities issued by the U.S. Treasury, money markets, and certain agency and corporate CMOs. Inputs to the pricing models include standard inputs (i.e. yields, benchmark securities, bids, and offers), actual trade data (i.e. spreads, credit ratings, and interest rates) for comparable assets, spread tables, matrices, high-grade scales, and option-adjusted spreads.

•

Securities are classified as Level 3 when there is limited activity in the market for a particular instrument. To determine fair value in such cases, depending on the complexity of the valuations required, we use internal models based on certain assumptions or a third-party valuation service. At March 31, 2018, our Level 3 instruments consist of debt securities. Our Corporate Strategy group is responsible for reviewing the valuation model and determining the fair value of these investments on a quarterly basis. The securities are valued using a cash flow analysis of the associated private company issuers. The valuations of the securities are negatively affected by projected net losses of the associated private companies and positively affected by projected net gains.

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 securities issued by state and political subdivisions, inputs used by the third-party pricing service also include material event notices.

On a monthly basis, we validate the pricing methodologies utilized by our third-party pricing service to ensure that 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.

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) and indirect investments (investments made through funds that include other investors). Our principal investing entities are accounted for as investment companies in accordance with the applicable accounting guidance, whereby 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 (individuals from one of the independent investment managers who oversee these instruments), accounting staff, and the Investment Committee (individual employees 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 private companies. 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.

Our 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 allowing 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). Under the requirements of the Volcker

Rule, we will be required to dispose of some or all of our indirect investments. On February 14, 2017, Key’s

application for an extension to comply with this rule for illiquid funds was approved. Key will retain certain indirect

investments until the earlier of the date on which the investment is conformed or is expected to mature, but no later than July 21, 2022; as of March 31, 2018, we have not committed to a plan to sell these investments, therefore, these investments continue to be valued using the net asset value per share methodology.

The following table presents the fair value of our direct and indirect principal investments and related unfunded commitments at March 31, 2018, as well as financial support provided for the three months ended March 31, 2018, and March 31, 2017.



					Financial support provided
					Three months ended March 31,
	March 31, 2018				2018		2017
in millions	Fair Value		Unfunded Commitments		Funded Commitments	Funded Other	Funded Commitments		Funded Other
INVESTMENT TYPE
Direct investments ^(a)	$	12	—		—	—	—		—
Indirect investments^(b) (measured at NAV)	114		$	29	—	—	$	1	—
Total	$	126	$	29	—	—	$	1	—

(a)

Our direct investments consist of equity and debt investments directly in independent business enterprises. Operations of the business enterprises are handled by management of the portfolio company. The purpose of funding these enterprises is to provide financial support for business development and acquisition strategies. We infuse equity capital based on an initial contractual cash contribution and later from additional requests on behalf of the companies’ management.

(b)

Our indirect investments consist of buyout funds, venture capital funds, and fund of funds. These investments are generally not redeemable. Instead, distributions are received through the liquidation of the underlying investments of the fund. An investment in any one of these funds typically 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 six years. The purpose of funding our capital commitments to these investments is to allow the funds to make additional follow-on investments and pay fund expenses until the fund dissolves. We, and all other investors in the fund, are obligated to fund the full amount of our respective capital commitments to the fund based on our and their respective ownership percentages, as noted in the applicable Limited Partnership Agreement.

Other Equity Investments. Our other equity investments are direct investments in equity instruments of private companies. Quoted market prices are not available for these investments and we must perform valuations using other methods in a similar manner to our direct principal investments. 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. Accordingly, these investments are classified as Level 3 assets.

Loans Held for Sale. As of August 1, 2016, we account for our residential mortgage loans held for sale at fair value on a recurring basis. The election of the fair value option aligns the accounting for the residential mortgages held for sale with the related forward mortgage loan sale commitments.

Residential mortgage loans are valued based on quoted market prices, where available, prices for other traded mortgage loans with similar characteristics, and purchase commitments and bid information received from market participants. The prices are adjusted as necessary to include the embedded servicing value in the loans and to take into consideration the specific characteristics of certain loans that are priced based on the pricing of similar loans. These adjustments represent unobservable inputs to the valuation, but are not considered significant given the relative insensitivity of the fair value of the loans when changes are made to these inputs. Accordingly, the majority of residential mortgage loans held for sale are classified as Level 2. Our residential mortgage activity also includes temporarily unsalable residential mortgage loans that are included in “Loans, net of unearned income” and loans with salability issues included in “Loans held for sale” on the balance sheet. These loans have an origination defect that makes them temporarily unable to be sold into the performing loan sales market. Because transaction details regarding sales of this type of loan are often unavailable, unobservable bid information from brokers and investors is heavily relied upon. Accordingly, based on the significance of unobservable inputs, these loans are classified as Level 3.

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, LIBOR and Overnight Index Swap 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), as well as current prices for mortgage securities and investor supplied prices. These derivative contracts, which are classified as Level 2 instruments, include interest rate swaps, certain options, cross-currency swaps, credit default swaps, and forward mortgage loan sale commitments.

We have several customized derivative instruments and risk participations that are classified as Level 3 instruments. These derivative positions are priced monthly by our MRM group using a model acquired from a third party that employs a credit valuation adjustment methodology. The model utilizes inputs consisting of available market data, including bond spreads and asset values, as well as unobservable, internally derived assumptions, such as loss probabilities and internal risk ratings of customers. Swap details with the customer and our related participation percentage, if applicable, are obtained from our derivatives accounting system. Applicable customer rating information is obtained from the relevant loan system and represents an unobservable input to this valuation process. 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.

We use interest rate lock commitments for our residential mortgage business. These instruments are accounted for as derivatives and valued using models containing unobservable significant inputs. For valuation purposes, the loan amount associated with each interest rate lock commitment is adjusted by its modeled pull through (an unobservable input) defined as the percentage of loans that will close prior to the expiration of the rate lock commitment, as adjusted for approved changes to the terms. Based on the significance of unobservable inputs, these instruments are classified as Level 3.

Market convention implies a credit rating of “AA” equivalent in the pricing of derivative contracts, which assumes that 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 credit valuation adjustment. The credit component is determined by individual counterparty based on the probability of default and considers master netting and collateral agreements. The credit valuation adjustment is classified as Level 3. Our MRM group is responsible for the valuation policies and procedures related to this credit valuation adjustment. 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 accounting personnel. On a quarterly basis, MRM prepares the credit valuation adjustment calculation, which includes a detailed reserve comparison with the previous quarter, an analysis for change in reserve, and a reserve forecast to ensure that the credit valuation adjustment recorded at period end is sufficient.

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 March 31, 2018, and December 31, 2017.



March 31, 2018	Level 1		Level 2		Level 3		Total
in millions
ASSETS MEASURED ON A RECURRING BASIS
Trading account assets:
U.S. Treasury, agencies and corporations	—		$	500	—		$	500
States and political subdivisions	—		81		—		81
Other mortgage-backed securities	—		118		—		118
Other securities	—		59		—		59
Total trading account securities	—		758		—		758
Commercial loans	—		11		—		11
Total trading account assets	—		769		—		769
Securities available for sale:
U.S. Treasury, agencies and corporations	—		146		—		146
States and political subdivisions	—		9		—		9
Agency residential collateralized mortgage obligations	—		14,566		—		14,566
Agency residential mortgage-backed securities	—		1,341		—		1,341
Agency commercial mortgage-backed securities	—		1,806		—		1,806
Other securities	—		—		$	20	20
Total securities available for sale	—		17,868		20		17,888
Other investments:
Principal investments:
Direct	—		—		12		12
Indirect (measured at NAV) ^(a)	—		—		—		114
Total principal investments	—		—		12		126
Equity investments:
Direct	—		—		7		7
Direct (measured at NAV) ^(a)	—		—		—		1
Total equity investments	—		—		7		8
Total other investments	—		—		19		134
Loans, net of unearned income	—		—		2		2
Loans held for sale	—		46		1		47
Derivative assets:
Interest rate	—		361		4		365
Foreign exchange	$	82	40		—		122
Commodity	—		345		—		345
Credit	—		—		—		—
Other	—		3		3		6
Derivative assets	82		749		7		838
Netting adjustments ^(b)	—		—		—		(207		)
Total derivative assets	82		749		7		631
Accrued income and other assets	—		—		—		—
Total assets on a recurring basis at fair value	$	82	$	19,432	$	49	$	19,471
LIABILITIES MEASURED ON A RECURRING BASIS
Bank notes and other short-term borrowings:
Short positions	$	92	$	541	—		$	633
Derivative liabilities:
Interest rate	—		388		—		388
Foreign exchange	78		37		—		115
Commodity	—		334		—		334
Credit	—		3		—		3
Other	—		18		—		18
Derivative liabilities	78		780		—		858
Netting adjustments ^(b)	—		—		—		(483		)
Total derivative liabilities	78		780		—		375
Accrued expense and other liabilities	—		—		—		—
Total liabilities on a recurring basis at fair value	$	170	$	1,321	—		$	1,008


(a)	Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheet.

(b)

Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance. 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 cash collateral. Total derivative assets and liabilities include these netting adjustments.



December 31, 2017	Level 1		Level 2		Level 3		Total
in millions
ASSETS MEASURED ON A RECURRING BASIS
Trading account assets:
U.S. Treasury, agencies and corporations	—		$	615	—		$	615
States and political subdivisions	—		37		—		37
Other mortgage-backed securities	—		104		—		104
Other securities	—		65		—		65
Total trading account securities	—		821		—		821
Commercial loans	—		15		—		15
Total trading account assets	—		836		—		836
Securities available for sale:
U.S. Treasury, agencies and corporations	—		157		—		157
States and political subdivisions	—		9		—		9
Agency residential collateralized mortgage obligations	—		14,660		—		14,660
Agency residential mortgage-backed securities	—		1,439		—		1,439
Agency commercial mortgage-backed securities	—		1,854		—		1,854
Other securities	—		—		$	20	20
Total securities available for sale	—		18,119		20		18,139
Other investments:
Principal investments:
Direct	—		—		13		13
Indirect (measured at NAV) ^(a)	—		—		—		124
Total principal investments	—		—		13		137
Equity investments:
Direct	—		4		3		7
Total equity investments	—		4		3		7
Total other investments	—		4		16		144
Loans, net of unearned income	—		—		2		2
Loans held for sale	—		70		1		71
Derivative assets:
Interest rate	—		713		9		722
Foreign exchange	$	100	30		—		130
Commodity	—		255		—		255
Credit	—		—		1		1
Other	—		1		3		4
Derivative assets	100		999		13		1,112
Netting adjustments ^(b)	—		—		—		(443		)
Total derivative assets	100		999		13		669
Accrued income and other assets	—		—		—		—
Total assets on a recurring basis at fair value	$	100	$	20,028	$	52	$	19,861
LIABILITIES MEASURED ON A RECURRING BASIS
Bank notes and other short-term borrowings:
Short positions	$	72	$	562	—		$	634
Derivative liabilities:
Interest rate	—		520		—		520
Foreign exchange	98		26		—		124
Commodity	—		246		—		246
Credit	—		4		—		4
Other	—		13		—		13
Derivative liabilities	98		809		—		907
Netting adjustments ^(b)	—		—		—		(616		)
Total derivative liabilities	98		809		—		291
Accrued expense and other liabilities	—		—		—		—
Total liabilities on a recurring basis at fair value	$	170	$	1,371	—		$	925


(a)	Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheet.

(b)

Changes in Level 3 Fair Value Measurements

The following table shows the components of the change in the fair values of our Level 3 financial instruments for the three months ended March 31, 2018, and March 31, 2017. 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 Other Comprehensive Income		Gains (Losses) Included in Earnings				Purchases	Sales	Settlements		Transfers Other	Transfers into Level 3 ^(a)			Transfers out of Level 3^(a)				End of Period Balance ^(f)		Unrealized Gains (Losses) Included in Earnings
Three months ended March 31, 2018
Securities available for sale
Other securities	$	20	$	—	—				—	—	—		—	—			—				$	20	—
Other investments
Principal investments
Direct	13		—		$	(1	)	^(b)	—	—	—		—	—			—				12		$	(1	)	^(b)
Equity investments
Direct	3		—		—				—	—	—		—	$	4		—				7		—
Loans held for sale	1		—		—				—	—	—		—	—			—				1		—
Loans held for investment	2		—		—				—	—	—		—	—			—				2		—
Derivative instruments ^(c)
Interest rate	9		—		(1		)	^(d)	—	—	—		—	1		^(e)	$	(5	)	^(e)	4		—
Credit	1		—		(5		)	^(d)	—	—	$	4	—	—			—				—		—
Other ^(f)	3		—		—				—	—	—		—	—			—				3		—



in millions	Beginning of Period Balance		Gains (Losses) Included in Other Comprehensive Income		Gains (Losses) Included in Earnings				Purchases	Sales			Settlements		Transfers Other		Transfers into Level 3 ^(a)			Transfers out of Level 3 ^(a)				End of Period Balance		Unrealized Gains (Losses) Included in Earnings
Three months ended March 31, 2017
Securities available for sale
Other securities	$	17	—		—				—	—			—		—		—			—				$	17	—
Other investments
Principal investments
Direct	27		$	—	$	(2	)	^(b)	—	$	(4	)	—		—		—			—				21		$	(6	)	^(b)
Derivative instruments ^(c)
Interest rate	7		—		—				—	—			—		—		$	1	^(e)	$	(3	)	^(e)	5		—
Credit	1		—		(3		)	^(d)	—	—			$	3	—		—			—				1		—
Other ^(g)	2		—		—				—	—			—		$	2	—			—				4		—


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


(b)	Realized and unrealized gains and losses on principal investments are reported in “other income” on the income statement.


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


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


(e)	Certain derivatives previously classified as Level 2 were transferred to Level 3 because Level 3 unobservable inputs became significant. Certain derivatives previously classified as Level 3 were transferred to Level 2 because Level 3 unobservable inputs became less significant.


(f)	Amounts represent Level 3 interest rate lock commitments.

Assets and Liabilities 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. There were no liabilities measured at fair value on a nonrecurring basis at March 31, 2018, and December 31, 2017. The following table presents our assets measured at fair value on a nonrecurring basis at March 31, 2018, and December 31, 2017:



	March 31, 2018							December 31, 2017
in millions	Level 1	Level 2		Level 3		Total		Level 1	Level 2		Level 3			Total
ASSETS MEASURED ON A NONRECURRING BASIS
Impaired loans	—	$	3	—		$	3	—	—		$	9		$	9
Accrued income and other assets	—	—		$	7	7		—	$	5	133		^(a)	138
Total assets on a nonrecurring basis at fair value	—	$	3	$	7	$	10	—	$	5	$	142		$	147


(a)	At December 31, 2017, we recorded $31 million of impairment related to $119 million of LIHTC and Historic Tax Credit investments impacted by the enactment of the TCJ Act. Refer to the “LIHTC and Historic Tax Credit Investments” section below for a description of the valuation technique and inputs applied for this fair value measurement.

Impaired loans. Loans are evaluated for impairment on a quarterly basis. Loans included in the previous quarter’s review are re-evaluated, and if their values have changed materially, the underlying information (loan balance and in most cases, collateral value) is compared. Material differences are evaluated for reasonableness, and the relationship managers and their senior managers consider these differences 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, if 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.

We 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 a cash flow analysis or the value of

the underlying collateral are classified as Level 3 assets. Impaired loans 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 assets.

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 loan charge-offs on closed deals

compared to the specific allocations on such deals is considered in determining each quarter’s specific allocations.

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 Credit Officer. These evaluations are performed in

conjunction with the quarterly ALLL process.

Commercial loans held for sale. Through a quarterly analysis of our loan portfolios held for sale, which include both performing and nonperforming commercial loans, we determine any adjustments necessary to record the portfolios at the lower of cost or fair value in accordance with GAAP. Our analysis concluded that there were no commercial loans held for sale adjusted to fair value at March 31, 2018, and December 31, 2017.

Direct financing leases and operating lease assets held for sale. Our 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 the KEF line of business. A weekly report that lists all equipment finance deals booked in the warehouse portfolio is distributed to both groups. 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 whether 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 on 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. KEF has master sale and assignment agreements with numerous institutional investors. Historically, multiple quotes are obtained, with the most reasonable formal quotes retained. These nonbinding quotes generally lead to a sale to one of the parties who provided the quote. Leases for which we receive a current nonbinding bid, and for which the sale is considered probable, may be classified as Level 2. The validity of these quotes is supported by historical and continued dealings with these institutions that have fulfilled the nonbinding quote in the past. In a distressed market where market data were 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.

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, 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.

•

Residential Real Estate Valuation Process: The Asset Management team within our Risk Operations group is responsible for valuation policies and procedures of these loans. 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. Third-party broker price opinions are reviewed every 180 days, and the fair value is written down based on changes to the valuation. External factors are documented and monitored as appropriate.

LIHTC and Historic Tax Credit Investments. LIHTC and Historic Tax Credit (HTC) operating partnerships are

subject to quarterly impairment testing. This evaluation involves measuring the present value of future tax benefits

and comparing that value against the current carrying value of the investment. Expected future tax benefit

schedules are provided by the partnerships’ general partners on a quarterly basis. These future benefits are

discounted to their present value using discounted cash flow modeling that incorporates an appropriate risk

premium. LIHTC and HTC investments are impaired when it is more likely than not that the carrying amount of the

investment will not be realized. A primarily driver of impairment in the fourth quarter of 2017 was the enactment of

the TCJ Act, which reduced future depreciation tax benefits expected to be realized by certain LIHTC and HTC

investments.

Other Equity Investments. We have other investments in equity securities that do not have readily determinable fair values and do not qualify for the practical expedient to measure the investment using a net asset value per share. We have elected to measure these securities at cost less impairment plus or minus adjustments due to observable orderly transactions. At each reporting period, we assess if these investments continue to qualify for this measurement alternative. At March 31, 2018, the carrying amount of equity investments recorded under this method was $95 million. No impairment was recorded for the three months ended March 31, 2018. Impairment is recorded when there is evidence that the expected fair value of the investment has declined to below the recorded cost.

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 March 31, 2018, and December 31, 2017, along with the valuation techniques used, are shown in the following table:



March 31, 2018	Fair Value of Level 3 Assets		Valuation Technique	Significant Unobservable Input	Weighted Average
dollars in millions	Fair Value of Level 3 Assets		Valuation Technique	Significant Unobservable Input	Weighted Average
Recurring
Other investments — principal investments — direct:	$	12	Individual analysis of the condition of each investment
Debt instruments				EBITDA multiple	6.00
Equity instruments of private companies				EBITDA multiple	6.00
Nonrecurring
Impaired loans	—		Fair value of underlying collateral	Discount	N/A



December 31, 2017	Fair Value of Level 3 Assets		Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
dollars in millions	Fair Value of Level 3 Assets		Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
Recurring
Other investments — principal investments — direct:	$	13	Individual analysis of the condition of each investment
Debt instruments				EBITDA multiple	N/A (6.00)
Equity instruments of private companies				EBITDA multiple	N/A (6.00)
Nonrecurring
Impaired loans	9		Fair value of underlying collateral	Discount	00.00 - 50.00% (23.00%)

Fair Value Disclosures of Financial Instruments

The levels in the fair value hierarchy ascribed to our financial instruments and the related carrying amounts at March 31, 2018, and December 31, 2017, are shown in the following tables. Assets and liabilities are further arranged by measurement category.



	March 31, 2018
			Fair Value
in millions	Carrying Amount		Level 1		Level 2		Level 3		Measured at NAV		Netting Adjustment				Total
ASSETS (by measurement category)
Fair value - net income
Trading account assets ^(b)	$	769	—		$	769	—		—		—				$	769
Other investments ^(b)	715		—		—		$	600	$	115	—				715
Loans, net of unearned income ^(d)	2		—		—		2		—		—				2
Loans held for sale ^(b)	47		—		46		1		—		—				47
Derivative assets - trading ^(b)	603		$	81	710		7		—		$	(195	)	^(f)	603
Fair value - OCI
Securities available for sale ^(b)	17,888		—		17,868		$	20	—		—				17,888
Derivative assets - hedging ^(b)	28		1		39		—		—		(12		)	^(f)	28
Amortized cost
Held-to-maturity securities ^(c)	12,189		—		11,729		—		—		—				11,729
Loans, net of unearned income ^(d)	87,206		—		—		85,166		—		—				85,166
Loans held for sale ^(b)	1,620		—		—		1,620		—		—				1,620
Other
Cash and short-term investments ^(a)	2,287		2,287		—		—		—		—				2,287
LIABILITIES (by measurement category)
Fair value - net income
Derivative liabilities - trading ^(b)	$	371	$	74	$	778	—		—		$	(481	)	^(f)	$	371
Fair value - OCI
Derivative liabilities - hedging ^(b)	4		4		2		—		—		(2		)	^(f)	4
Amortized cost
Time deposits ^(e)	12,223		—		12,285		—		—		—				12,285
Short-term borrowings ^(a)	1,749		$	92	1,657		—		—		—				1,749
Long-term debt ^(e)	13,749		12,176		1,690		—		—		—				13,866
Other
Deposits with no stated maturity^(a)	92,528		—		92,528		—		—		—				93,588



	December 31, 2017
				Fair Value
in millions	Carrying Amount			Level 1		Level 2		Level 3		Measured at NAV		Netting Adjustment				Total
ASSETS (by measurement category)
Fair value - net income
Trading account assets ^(b)	$	836		—		$	836	—		—		—				$	836
Other investments ^(b)	726			—		4		$	598	$	124	—				726
Loans, net of unearned income ^(d)	2			—		—		2		—		—				2
Loans held for sale ^(b)	71			—		70		1		—		—				71
Derivative assets - trading ^(b)	681			$	99	918		13		—		$	(349	)	^(f)	681
Fair value - OCI
Securities available for sale ^(b)	18,139			—		18,119		20		—		—				18,139
Derivative assets - hedging ^(b)	(12		)	1		81		—		—		(94		)	^(f)	(12		)
Amortized cost
Held-to-maturity securities ^(c)	11,830			—		11,565		—		—		—				11,565
Loans, net of unearned income ^(d)	85,526			—		—		84,003		—		—				84,003
Loans held for sale ^(b)	1,036			—		—		1,036		—		—				1,036
Other
Cash and short-term investments ^(a)	5,118			5,118		—		—		—		—				5,118
LIABILITIES (by measurement category)
Fair value - net income
Derivative liabilities - trading ^(b)	$	289		$	94	$	763	—		—		$	(568	)	^(f)	$	289
Fair value - OCI
Derivative liabilities - hedging ^(b)	2			4		46		—		—		(48		)	^(f)	2
Amortized cost
Time deposits ^(e)	11,647			—		11,750		—		—		—				11,750
Short-term borrowings ^(a)	1,011			72		939		—		—		—				1,011
Long-term debt ^(e)	14,333			13,407		$	1,219	—		—		—				14,626
Other
Deposits with no stated maturity^(a)	93,588			—		93,588		—		—		—				93,588

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)

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 and Liabilities Measured at Fair Value on a Nonrecurring Basis” in this Note. Investments accounted for under the cost method (or cost less impairment adjusted for observable price changes for certain equity investments) are classified as Level 3 assets. These investments are not actively traded in an open market as sales for these types of investments are rare. The carrying amount of the investments carried at cost are adjusted for declines in value if they are considered to be other-than-temporary (or due to observable orderly transactions of the same issuer for equity investments eligible for the cost less impairment measurement alternative). These adjustments are included in “other income” on the income statement.

(c)

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 that they are reasonable and consistent with the values placed on similar securities traded in the secondary markets.

(d)

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.


(e)	Fair values of time deposits and long-term debt are based on discounted cash flows utilizing relevant market inputs.

(f)

We determine fair value based on assumptions pertaining to the factors that a market participant would consider in

valuing the asset. A substantial portion of our fair value adjustments are related to liquidity. During 2017 and the first quarter of 2018, the fair values of our loan portfolios generally remained stable, 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. 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 loans in portfolio recorded at carrying value with appropriate valuation reserves, and loans in portfolio recorded at fair value. All of these loans were excluded from the table above as follows:


•	Loans at carrying value, net of allowance, of $1.2 billion ($1.1 billion at fair value) at March 31, 2018, and $1.3 billion ($1.1 billion at fair value) at December 31, 2017;


•	Portfolio loans at fair value of $2 million at March 31, 2018, and $2 million at December 31, 2017.

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.

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.