Basis of Presentation and Accounting Policies

6 Months Ended

Jun. 30, 2020

Organization, Consolidation and Presentation of Financial Statements [Abstract]

Basis of Presentation and Accounting Policies

1. Basis of Presentation and Accounting Policies

The consolidated financial statements include the accounts of KeyCorp and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Some previously reported amounts have been reclassified to conform to current reporting practices.

The consolidated financial statements include any voting rights entities in which we have a controlling financial interest. In accordance with the applicable accounting guidance for consolidations, we consolidate a VIE if we have: (i) a variable interest in the entity; (ii) the power to direct activities of the VIE that most significantly affect the entity’s economic performance; and (iii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE (i.e., we are considered to be the primary beneficiary). Variable interests can include equity interests, subordinated debt, derivative contracts, leases, service agreements, guarantees, standby letters of credit, loan commitments, and other contracts, agreements, and financial instruments. See Note 10 (“Variable Interest Entities”) for information on our involvement with VIEs.

We use the equity method to account for unconsolidated investments in voting rights entities or VIEs if we have significant influence over the entity’s operating and financing decisions (usually defined as a voting or economic interest of 20% to 50%, but not controlling). Unconsolidated investments in voting rights entities or VIEs in which we have a voting or economic interest of less than 20% are carried at the cost measurement alternative or at fair value. Investments held by our registered broker-dealer and investment company subsidiaries (principal investing entities and Real Estate Capital line of business) are carried at fair value.

We believe that the unaudited consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures that are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full year. The interim financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our 2019 Form 10-K.

In preparing these financial statements, subsequent events were evaluated through the time the financial statements were issued. Financial statements are considered issued when they are widely distributed to all shareholders and other financial statement users or filed with the SEC.

Accounting Guidance Adopted in 2020

Measurement of Credit Losses on Financial Instruments (ASU 2016-13, ASU 2018-19, ASU 2019-04, ASU 2019-05, ASU 2019-11, ASU 2020-02, ASU 2020-03)

On January 1, 2020, we adopted ASU 2016-13, Financial Instruments - Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments, which replaces the incurred-loss methodology that recognized losses when a probable threshold was met with an expected-loss methodology, specifically, recognizing current expected credit losses (CECL) for the remaining life of the asset at the time of origination or acquisition. The CECL methodology applies to loans, debt securities, and other financial assets and net investment in leases measured at amortized cost. It also applies to off-balance sheet credit exposures (loan commitments, standby letters of credit, financial guarantees, and other similar instruments). Assets in the scope of ASC 326 are presented at the net amount expected to be collected after deducting the allowance for credit losses from the amortized cost basis of the assets.

ASC 326 also requires credit losses relating to available-for-sale debt securities that management does not intend to sell or believes that it is more likely than not they will be required to sell to be recorded through an allowance rather than a reduction of the carrying amount.

ASC 326 replaces the purchased credit impaired concept of accounting, previously required under Subtopic 310-30, with a purchased financial assets with credit deterioration (PCD) concept. In accordance with ASC 326, we did not reassess whether recognized purchased credit impaired loans met the criteria of a PCD loan and modifications to individual acquired loans accounted for in pools were TDRs as of the date of adoption. At adoption, we elected to not maintain the pools of loans previously accounted for under Subtopic 310-30.

The prospective application resulted in a $4 million adjustment to the amortized cost basis of PCD loans to reflect the addition to the allowance for loans and leases as of January 1, 2020. After the adjustment for the allowance for

the loans and leases, the noncredit discount of $15 million will be accreted to interest income using the interest method based on the effective interest rate determined after the adjustment from credit losses as of January 1, 2020.

The ASU requires use of a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. Results for reporting periods beginning after January 1, 2020, are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP. We posted an adjusting entry decreasing retained earnings as of January 1, 2020, by $230 million, net of deferred taxes of $71 million, for the cumulative effect of adopting ASC 326. The main drivers of the adjustment to retained earnings are summarized in the following table.

	Pre-ASC 326 Adoption		Impact of ASC 326 Adoption			As Reported Under ASC 326
in millions	December 31, 2019					January 1, 2020
Allowance for credit losses
Commercial
Commercial and industrial	$	551	$	(141	)	$	410
Real estate — commercial mortgage	143		16			159
Real estate — construction	22		(7		)	15
Commercial lease financing	35		8			43
Total commercial loans	751		(124		)	627
Consumer
Real estate — residential mortgage	7		77			84
Home equity loans	31		147			178
Consumer direct loans	34		63			97
Credit cards	47		35			82
Consumer indirect loans	30		6			36
Total consumer loans	149		328			477
Total ALLL — continuing operations	900		204			1,104
Discontinued operations	10		31			41
Total ALLL	910		235			1,145
Accrued expense and other liabilities	75		70			145
Total allowance for credit losses	$	985	$	305		$	1,290

In conjunction with the adoption of ASC 326, the following are additional disclosures about our significant accounting policies related to CECL.

Allowance for Held-to-Maturity Securities

Debt securities that we have the intent and ability to hold until maturity are classified as held-to-maturity and are carried at cost and adjusted for amortization of premiums and accretion of discounts using the interest method. This method produces a constant rate of return on the adjusted carrying amount.

Management classifies the held-to-maturity portfolio into the following major security types: agency residential collateralized mortgage obligations, agency residential mortgage-backed securities, agency commercial mortgage-backed securities, asset backed securities, and other. Management measures expected credit losses on held-to-maturity securities on a collective basis by major security type. The estimate of expected losses considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. We do not measure expected credit losses on held-to-maturity securities in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the amortized cost basis is zero.

All of our mortgage-backed securities are issued by U.S. government-sponsored enterprises or GNMA, are highly rated by major rating agencies and have a long history of no credit losses. Other securities are comprised of State of Israel bonds denominated and paid in U.S. dollars. Israel bonds have a long history of no credit losses. Additionally, as of June 30, 2020, the State of Israel's credit rating remains "stable" among Fitch, Moody's, and S&P (A+, A1, AA-).

Allowance for Available-for-Sale Securities

Debt securities that we intend to hold for an indefinite period of time but that may be sold in response to changes in interest rates, prepayment risk, liquidity needs, or other factors are classified as available-for-sale and reported at fair value. Realized gains and losses resulting from sales of securities using the specific identification method are included in “other income” on the income statement. Unrealized gains and losses (net of income taxes) are recorded in equity as a component of AOCI.

For available-for-sale securities in an unrealized loss position, we first assess whether we intend to sell, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If either of these criteria regarding intent or requirement to sell is met, the security's amortized cost basis is written down to fair value in “other income” on the income statement. For debt securities that do not meet the aforementioned criteria, we evaluate whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, nature of the security, the underlying collateral, and the financial condition of the issuer, among other factors. If this assessment indicates a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for available-for-sale securities is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for available-for-sale securities is recognized in other comprehensive income.

Changes in the allowance for available-for-sale securities are recorded as provision for (or reversal of) credit loss. Losses are charged against the allowance for available-for-sale securities when management believes the uncollectibility of an available-for-sale security is confirmed or when either criteria regarding intent or requirement to sell is met.

Loans

Accrued interest on loans is included in "other assets" on the balance sheet and is excluded from the calculation of the allowance for credit losses due to our charge-off policy to reverse accrued interest on nonperforming loans against interest income in a timely manner. We have not classified loans that receive a payment deferral or forbearance under a COVID-19 hardship relief program as nonperforming loans and continue to accrue and recognize interest income during the period of the deferral. We, therefore, recognize an allowance for credit losses for accrued interest receivable amounts that result from deferred payments under a COVID-19 hardship relief program because those amounts would not be considered to be written off in a timely manner. As of June 30, 2020, the allowance for credit losses on accrued interest receivable was immaterial.

Expected credit losses on net investments in leases, including any unguaranteed residual asset, are included in the ALLL.

Purchased Credit Deteriorated (PCD) Loans

In addition to originating loans, we also acquire loans through portfolio purchases or acquisitions of other financial services companies. Purchased loans that have evidence of more than insignificant credit deterioration since origination are deemed PCD loans. In accordance with ASC 326, we did not reassess whether recognized purchased credit impaired loans met the criteria of a PCD loan as of the date of adoption. PCD loans are initially recorded at fair value along with an allowance for credit losses determined using the same methodology as originated loans. The sum of the loan's purchase price and allowance for credit losses becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent changes to the allowance for credit losses are recorded through provision for credit losses.

Nonperforming Loans

Nonperforming loans are loans for which we do not accrue interest income, and include commercial and consumer loans and leases, as well as current year TDRs and nonaccruing TDR loans from prior years. Nonperforming loans do not include loans held for sale. Once a loan is designated nonaccrual, the interest accrued but not collected is

reversed against interest income, and payments subsequently received are applied to principal until qualifying for return to accrual.

Allowance for Loan and Lease Losses

We estimate the ALLL using relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. The ALLL is measured on a collective (pool) basis when similar risk characteristics exist. Our portfolio segments include commercial and consumer. Each of these two segments comprises multiple loan classes. Classes are characterized by similarities in initial measurement, risk attributes, and the manner in which we monitor and assess credit risk. The commercial segment is composed of commercial and industrial, commercial real estate, and commercial lease financing loan classes. The consumer lending segment is composed of residential mortgage, home equity, consumer direct, credit card, and consumer indirect loan classes.

The ALLL represents our current estimate of lifetime credit losses inherent in our loan portfolio at the balance sheet date. In determining the ALLL, we estimate expected future losses for the loan's entire contractual term adjusted for expected prepayments when appropriate. The contractual term excludes expected extensions, renewals, and modifications.

The ALLL is the sum of three components: (i) asset specific/ individual loan reserves; (ii) quantitative (formulaic or pooled) reserves; and (iii) qualitative (judgmental) reserves.

Asset Specific / Individual Component

Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluation. We have elected to apply the practical expedient to measure expected credit losses of a collateral dependent asset using the fair value of the collateral, less any costs to sell, when foreclosure is not probable, when repayment of the loan is expected to be provided substantially through the operation or sale of the collateral, and the borrower is experiencing financial difficulty.

Individual reserves are determined as follows:

• For commercial non-accruing loans greater than or equal to a defined dollar threshold, individual reserves are determined based on an analysis of the present value of the loan's expected future cash flows, the loan's observable market value, or the fair value of the collateral less costs to sell.

• For commercial non-accruing loans below the defined dollar threshold, an established LGD percentage is multiplied by the loan balance and the results are aggregated for purposes of measuring specific reserve impairment.

• The population of individually assessed consumer loans includes loans deemed collateral dependent, in addition to all TDRs. The expected loss for these loans is estimated based on the present value of the loan's expected future cash flows, except in instances where the loan is collateral dependent, in which case the loan is written down based on the collateral's fair market value less costs to sell.

Quantitative Component

We use a non-DCF factor-based approach to estimate expected credit losses that include component PD/LGD/EAD models as well as less complex estimation methods for smaller loan portfolios.

• PD: This component model is used to estimate the likelihood that a borrower will cease making payments as agreed. The major contributors to this are the borrower credit attributes and macro-economic trends. The objective of the PD model is to produce default likelihood forecasts based on the observed loan-level information and projected paths of macroeconomic variables.

• LGD: This component model is used to estimate the loss on a loan once a loan is in default.

• EAD: Estimates the loan balance at the time the borrower stops making payments. For all term loans, an amortization based formulaic approach is used for account level EAD estimates. We calculate EAD using a portfolio specific method in each of our revolving product portfolios. For line products that are unconditionally cancellable, the balances will either use a paydown curve or be held flat through the life of the loan.

Additional information about the critical estimates and judgments we make in developing these models is provided in the section “Allowance for loan and lease losses” under the heading “Critical Accounting Policies and Estimates” in Item 2 of this report.

Qualitative Component

The ALLL also includes identified qualitative factors related to idiosyncratic risk factors, changes in current economic conditions that may not be reflected in quantitatively derived results, and other relevant factors to ensure the ALLL reflects our best estimate of current expected credit losses.

While our reserve methodologies strive to reflect all relevant risk factors, there continues to be uncertainty associated with, but not limited to, potential imprecision in the estimation process due to the inherent time lag

of obtaining information and normal variations between estimates and actual outcomes. We provide additional reserves that are designed to provide coverage for losses attributable to such risks. The ALLL also includes factors that may not be directly measured in the determination of individual or collective reserves. Such qualitative factors may include:

• The nature and volume of the institution’s financial assets;

• The existence, growth, and effect of any concentrations of credit;

• The volume and severity of past due financial assets, the volume of nonaccrual assets, and the volume and severity of adversely classified or graded assets;

• The value of the underlying collateral for loans that are not collateral dependent;

• The institution’s lending policies and procedures, including changes in underwriting standards and practices for collections, write-offs, and recoveries;

• The quality of the institution’s credit review function;

• The experience, ability, and depth of the institution’s lending, investment, collection, and other relevant management and staff;

• The effect of other external factors such as the regulatory, legal and technological environments; competition; and events such as natural disasters; and

• Actual and expected changes in international, national, regional, and local economic and business conditions and developments in which the institution operates that affect the collectability of financial assets.

Liability for Credit Losses on Lending-Related Commitments

The liability for credit losses on lending-related commitments, such as letters of credit and unfunded loan commitments, is included in “accrued expense and other liabilities” on the balance sheet. Expected credit losses are estimated over the contractual period in which we are exposed to credit risk via a contractual obligation unless that obligation is unconditionally cancellable by us. The liability for credit losses on lending-related commitments is adjusted as a provision for credit losses. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated useful life. Consistent with our estimation process on our loan and lease portfolio, we use a non-DCF factor-based approach to estimate expected credit losses that include component PD/LGD/EAD models as well as less complex estimation methods for smaller portfolios.

Allowance for Credit Losses on Other Financial Assets

The allowance for credit losses on other financial assets, such as other receivables and servicing advances, is determined based on historical loss information and other available indicators. If such information does not indicate any expected credit losses, Key may estimate the allowance for credit losses on other financial assets to be zero or close to zero. As of June 30, 2020, the allowance for credit losses on other financial assets was immaterial.

Simplifying the Test for Goodwill Impairment (ASU 2017-04)

On January 1, 2020, we adopted ASU 2017-04. The ASU amends ASC Topic 350, Intangibles - Goodwill and Other and eliminates the second step of the test for goodwill impairment. Goodwill represents the amount by which the cost of net assets acquired in a business combination exceeds their fair value. Goodwill is assigned to reporting units as of the acquisition date based on the expected benefit to such reporting unit from the synergies of the business combination. Goodwill is not amortized. Goodwill is tested at the reporting unit level for impairment, at least annually as of October 1, or when indicators of impairment exist.

When indicators of impairment exist we may look to both quantitative and qualitative information to determine whether or not it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount. Factors considered in the assessment include, but are not limited to, macroeconomic conditions, industry and market considerations, stock performance, financial performance of the reporting units, and previous results of goodwill impairment tests. When it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount a quantitative test is required. Under the new accounting guidance, the quantitative analysis requires the estimated fair value of each reporting unit to be compared to its carrying amount, including goodwill. If the estimated fair value of the reporting unit is less than its carrying value, an impairment charge would be recorded for the excess, not to exceed the amount of goodwill allocated to the reporting unit. The adoption of this accounting guidance must be applied prospectively and is not expected to have a material effect on our financial condition or results of operations.

Reference Rate Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting (ASU 2020-04)

We adopted ASU 2020-04 upon issuance. The amendments provide optional expedients and exceptions for certain contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of rate reform. The guidance is effective from the date of issuance until December 31, 2022. The guidance permits Key not to apply modification accounting or remeasure lease payments in lease contracts if the changes to the contract are related to the discontinuation of the reference rate. If certain criteria are met, the amendments also allow exceptions to the dedesignation criteria of the hedging relationship and the assessment of hedge effectiveness during the transition period. It also allows Key to make a one time election to sell, transfer, or both sell and transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and that are classified as held to maturity before January 1, 2020. This one time election may be made at any time after March 12, 2020, but no later than December 31, 2022. Key has not yet made a determination on whether it will make this election. At the time of adoption, the guidance did not have a significant impact on Key’s financial condition and results of operations. We will continue to assess the impact as the reference rate transition occurs over the next two years.