11. Acquisitions and Discontinued Operations

Acquisitions

Mortgage Servicing Rights. On June 24, 2013, in the first of multiple closings, we acquired substantially all third-party commercial loan servicing rights consisting of CMBS Master, Primary, and Special Servicing as well as other servicing from Bank of America’s Global Mortgages & Securitized Products business. Simultaneously, we entered into a subservicing agreement with Berkadia Commercial Mortgage LLC related to all CMBS primary servicing. This acquisition was accounted for as a business combination and aligned with our strategy to drive growth. At the time, the acquisition resulted in KeyBank becoming the third largest servicer of commercial/multifamily loans in the U.S. and the fifth largest special servicer of CMBS. The acquisition date fair value of the MSRs acquired on June 24, 2013, which were included on our balance sheet at June 30, 2013, was approximately $117 million. Three additional and related closings occurred on July 22, 2013, August 26, 2013, and October 7, 2013. The acquisition date fair value of the MSRs acquired in these transactions was $3 million. As a result of this acquisition, the total fair value of the MSRs acquired during 2013 and included in our December 31, 2013, financial results was $120 million. In addition to the MSRs acquired, Key, as a master servicer, acquired $216 million of principal and interest advances. These principal and interest advances recorded at fair value were primarily associated with the June 24, 2013, acquisition of MSRs. No goodwill was recognized as a result of this acquisition. Additional information regarding our mortgage servicing assets is provided in Note 8 (“Mortgage Servicing Assets”).

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.

“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 and the loans 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 and 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 expense related to the loans and securities are shown as a component 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 March 31,
in millions	2014			2013
Net interest income	$	23		$	28
Provision (credit) for loan and lease losses		4			6

Net interest income (expense) after provision for loan and lease losses		19			22
Noninterest income		(14	)		(16	)
Noninterest expense		6			7

Income (loss) before income taxes		(1	)		(1	)
Income taxes		—			(1	)

Income (loss) from discontinued operations, net of taxes ^(a)	$	(1	)		—

(a)	Includes after-tax charges of $9 million and $10 million for the three-month periods ended March 31, 2014, and 2013, respectively, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support the discontinued operations.

The discontinued assets and liabilities of our education lending business included on the balance sheet are as follows:


in millions	March 31, 2014		December 31, 2013		March 31, 2013
Trust loans at fair value	$	1,893	$	1,960	$	2,333
Portfolio loans at fair value		143		147		154
Loans, net of unearned income of ($6), ($6), and ($5)		2,318		2,390		2,599
Less: Allowance for loan and lease losses		34		39		49

Net loans		4,320		4,458		5,037
Trust accrued income and other assets at fair value		19		20		25
Accrued income and other assets		41		45		54

Total assets	$	4,380	$	4,523	$	5,116


Trust accrued expense and other liabilities at fair value	$	20	$	20	$	25
Trust securities at fair value		1,796		1,834		2,126

Total liabilities	$	1,816	$	1,854	$	2,151

The discontinued education lending business consists of assets and liabilities in the securitization trusts (recorded at fair value), as well as loans in portfolio (recorded at fair value) and loans in portfolio (recorded at carrying value with appropriate valuation reserves) that are held outside the trusts.

At March 31, 2014, education loans include 1,097 TDRs with a recorded investment of approximately $15 million (pre-modification and post-modification). A specifically allocated allowance of $1 million was assigned to these loans as of March 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 4 (“Asset Quality”).

In the past, as part of our education lending business model, we originated and securitized education loans. The process of securitization involved taking a pool of loans from our balance sheet and selling them to a bankruptcy-remote QSPE, or trust. This trust then issued securities to investors in the capital markets to raise funds to pay for the loans. The interest generated on the loans pays holders of the securities issued. As the transferor, we retain a portion of the risk in the form of a residual interest and also retain the right to service the securitized loans and receive servicing fees.

As of January 1, 2010, we consolidated our ten outstanding securitization trusts since we hold 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.

The trust assets can be used only to settle the obligations or securities the trusts issue; we cannot sell the assets or transfer the liabilities. The loans in the consolidated trusts consist of both private and government-guaranteed loans. The security holders or beneficial interest holders do not have recourse to Key. Our economic interest or risk of loss associated with these education loan securitization trusts was approximately $96 million as of March 31, 2014. During the third quarter of 2013, additional market participant information about projected trends for default and recovery rates became available. Based on this information and our related internal analysis, we adjusted certain assumptions related to valuing the loans and securities in the securitization trusts. As a result, a $48 million after-tax loss was recognized during the third quarter of 2013 related to the fair value of the loans and securities in the education loan securitization trusts. This loss resulted in a reduction in the value of our economic interest in these trusts. We record all income and expense (including fair value adjustments) through the “income (loss) from discontinued operations, net of tax” line item in our income statement.

On October 27, 2013, we purchased the government-guaranteed education loans from one of the education loan securitization trusts pursuant to the legal terms of the particular trust. The trust used the cash proceeds from the sale of these loans to retire the outstanding securities related to the government-guaranteed education loans. This particular trust remains in existence and continues to maintain the private education loan portfolio and has securities related to these loans outstanding. On December 20, 2013, we sold substantially all of the loans we purchased for $147 million and recognized a gain on the sale of $3 million.

At March 31, 2014, there were $136 million of loans that were purchased from three of the outstanding securitizations trusts pursuant to the legal terms of these particular trusts. These loans are held as portfolio loans and continue to be accounted for at fair value. These portfolio loans were valued using an internal discounted cash flow model, which was affected by assumptions for defaults, loss severity, discount rates, and prepayments. These portfolio loans are considered to be Level 3 assets since we rely on unobservable inputs when determining fair value. Our valuation process for these loans as well as the trust loans and securities is discussed in more detail below. Portfolio loans accounted for at fair value had a value of $143 million at March 31, 2014, $147 million at December 31, 2013, and $154 million at March 31, 2013.

We elected to consolidate the education loan securitization trusts at fair value. Carrying the assets and liabilities of the trusts at fair value better depicts our economic interest. The fair value of the assets and liabilities of the trusts is determined by calculating the present value of the future expected cash flows. We rely on unobservable inputs (Level 3) when determining the fair value of the assets and liabilities of the trusts because observable market data is not available. Our valuation process is described in more detail below.

Corporate Treasury, within our Finance area, is responsible for the quarterly valuation process that determines the fair value of the loans and securities in our education loan securitization trusts as well as our student loans held in portfolio that are accounted for at fair value. Corporate Treasury provides 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 5 (“Fair Value Measurements”). The Working Group reviews all significant inputs and assumptions and approves the resulting fair values.

The Working Group reviews actual performance trends of the loans and securities on a quarterly basis and uses statistical analysis and qualitative measures to determine assumptions for future performance. Predictive models that incorporate delinquency and charge-off trends along with economic outlooks assist the Working Group to forecast future defaults. The Working Group uses this information to formulate the credit outlook for each of the securitization trusts. 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 loans and securities in these securitization trusts as well as the portfolio loans at fair value. Default expectations and discount rate changes have the most significant impact on the fair values of the loans and securities. 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 and securities.

The valuation process for the education loan securitization trust and portfolio loans that are accounted for at fair value is based on a discounted cash flow analysis using a model purchased from a third party that is maintained by Corporate Treasury. The valuation process begins with loan-by-loan level data that is 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 are developed using a financial model that reflects certain assumptions for defaults, recoveries, status changes, and prepayments. A net earnings stream, taking into account cost of funding, is calculated and discounted back to the measurement date using an appropriate discount rate. This resulting amount is used to determine the present value of the loans, which represents their fair value to a market participant.

The unobservable inputs set forth in the following table are reviewed and approved by the Working Group on a quarterly basis. The Working Group determines these assumptions based on available data, discussions with appropriate individuals within and outside of Key, and the knowledge and experience of the Working Group members.

A similar discounted cash flow approach to that described above is used on a quarterly basis by Corporate Treasury to determine the fair value of the trust securities. In valuing these securities, the discount rates used are provided by a third-party valuation consultant. These discount rates are based primarily on secondary market spread indices for similar student loans and asset-backed securities and are developed by the consultant using market-based data. On a quarterly basis, the Working Group reviews the discount rate inputs used in the valuation process for reasonableness.

A quarterly variance analysis reconciles valuation changes in the model used to calculate the fair value of the trust loans and securities and the portfolio loans at fair value. This quarterly analysis considers loan and securities run-off, yields, future default and recovery changes, and the timing of cash releases to us from the trusts. We also perform back-testing to compare expected defaults to actual experience; the impact of future defaults can significantly affect the fair value of these loans and securities over time. In addition, our internal model validation group periodically performs a review to ensure the accuracy and validity of the model for determining the fair value of these loans and securities.

The following table shows the significant unobservable inputs used to measure the fair value of the education loan securitization trust loans and securities and the portfolio loans accounted for at fair value as of March 31, 2014, December 31, 2013, and March 31, 2013:


March 31, 2014	Fair Value of Level 3		Valuation	Significant	Range
dollars in millions	Assets and Liabilities		Technique	Unobservable Input	(Weighted-Average)
Trust loans and portfolio loans accounted for at fair value	$	2,036	Discounted cash flow	Prepayment speed	4.00 - 13.50% (6.62%)
				Loss severity	2.00 - 79.50% (53.89%)
				Discount rate	2.40 - 10.50% (3.51%)
				Default rate	8.05 - 23.87% (18.65%)

Trust securities		1,796	Discounted cash flow	Discount rate	1.60 - 3.50% (2.55%)


December 31, 2013	Fair Value of Level 3		Valuation	Significant	Range
dollars in millions	Assets and Liabilities		Technique	Unobservable Input	(Weighted-Average)
Trust loans and portfolio loans accounted for at fair value	$	2,107	Discounted cash flow	Prepayment speed	4.00 - 13.50% (6.47%)
				Loss severity	2.00 - 79.50% (54.21%)
				Discount rate	2.40 - 10.50% (3.50%)
				Default rate	8.01 - 23.71% (18.43%)

Trust securities		1,834	Discounted cash flow	Discount rate	1.60 - 3.50% (2.55%)


March 31, 2013	Fair Value of Level 3		Valuation	Significant	Range
dollars in millions	Assets and Liabilities		Technique	Unobservable Input	(Weighted-Average)
Trust loans and portfolio loans accounted for at fair value	$	2,487	Discounted cash flow	Prepayment speed	4.00 - 13.50% (6.16%)
				Loss severity	2.00 - 80.00% (52.29%)
				Discount rate	1.80 - 5.50% (3.89%)
				Default rate	8.13 - 22.00% (13.84%)

Trust securities		2,126	Discounted cash flow	Discount rate	1.10 - 5.00% (3.29%)

The following table shows the principal and fair value amounts for our trust loans at fair value, portfolio loans at fair value, and portfolio loans at carrying value at March 31, 2014, December 31, 2013, and March 31, 2013. 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 117 of our 2013 Form 10-K.


	March 31, 2014				December 31, 2013				March 31, 2013
dollars in millions	Principal		Fair Value		Principal		Fair Value		Principal		Fair Value
Trust loans at fair value
Accruing loans past due 90 days or more	$	25	$	25	$	25	$	25	$	33	$	32
Loans placed on nonaccrual status		10		10		12		12		13		12

Portfolio loans at fair value
Accruing loans past due 90 days or more	$	7	$	7	$	8	$	8	$	5	$	5
Loans placed on nonaccrual status		—		—		—		—		—		—

Portfolio loans at carrying value
Accruing loans past due 90 days or more	$	32		N/A	$	35		N/A	$	41		N/A
Loans placed on nonaccrual status		8		N/A		10		N/A		3		N/A

The following table shows the consolidated trusts’ assets and liabilities at fair value and the portfolio loans at fair value and their related contractual values as of March 31, 2014, December 31, 2013, and March 31, 2013.


	March 31, 2014				December 31, 2013				March 31, 2013
dollars in millions	Contractual Amount		Fair Value		Contractual Amount		Fair Value		Contractual Amount		Fair Value
ASSETS
Portfolio loans	$	136	$	143	$	140	$	147	$	148	$	154
Trust loans		1,889		1,893		1,964		1,960		2,357		2,333
Trust other assets		19		19		20		20		25		25

LIABILITIES
Trust securities	$	1,904	$	1,796	$	1,958	$	1,834	$	2,382	$	2,126
Trust other liabilities		20		20		20		20		25		25

The following tables present the assets and liabilities of the consolidated education loan securitization trusts measured at fair value as well as the portfolio loans that are measured at fair value on a recurring basis at March 31, 2014, December 31, 2013, and March 31, 2013.


March 31, 2014
in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans		—		—	$	143	$	143
Trust loans		—		—		1,893		1,893
Trust other assets		—		—		19		19

Total assets on a recurring basis at fair value		—		—	$	2,055	$	2,055

LIABILITIES MEASURED ON A RECURRING BASIS
Trust securities		—		—	$	1,796	$	1,796
Trust other liabilities		—		—		20		20

Total liabilities on a recurring basis at fair value		—		—	$	1,816	$	1,816


December 31, 2013
in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans		—		—	$	147	$	147
Trust loans		—		—		1,960		1,960
Trust other assets		—		—		20		20

Total assets on a recurring basis at fair value		—		—	$	2,127	$	2,127

LIABILITIES MEASURED ON A RECURRING BASIS
Trust securities		—		—	$	1,834	$	1,834
Trust other liabilities		—		—		20		20

Total liabilities on a recurring basis at fair value		—		—	$	1,854	$	1,854


March 31, 2013
in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans		—		—	$	154	$	154
Trust loans		—		—		2,333		2,333
Trust other assets		—		—		25		25

Total assets on a recurring basis at fair value		—		—	$	2,512	$	2,512

LIABILITIES MEASURED ON A RECURRING BASIS
Trust securities		—		—	$	2,126	$	2,126
Trust other liabilities		—		—		25		25

Total liabilities on a recurring basis at fair value		—		—	$	2,151	$	2,151

The following table shows the change in the fair values of the Level 3 consolidated education loan securitization trusts and portfolio loans for the three-month periods ended March 31, 2014, and 2013.


in millions	Portfolio Student Loans			Trust Student Loans			Trust Other Assets			Trust Securities			Trust Other Liabilities
Balance at December 31, 2013	$	147		$	1,960		$	20		$	1,834		$	20
Gains (losses) recognized in earnings ^(a)		—			2			—			16			—
Purchases		—			—			—			—			—
Sales		—			—			—			—			—
Settlements		(4	)		(69	)		(1	)		(54	)		—

Balance at March 31, 2014 ^(b)	$	143		$	1,893		$	19		$	1,796		$	20


Balance at December 31, 2012	$	157		$	2,369		$	26		$	2,159		$	22
Gains (losses) recognized in earnings ^(a)		—			43			—			59			—
Purchases		—			—			—			—			—
Sales		—			—			—			—			—
Settlements		(3	)		(79	)		(1	)		(92	)		3

Balance at March 31, 2013 ^(b)	$	154		$	2,333		$	25		$	2,126		$	25

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

(b)	There were no issuances, transfers into Level 3, or transfers out of Level 3 for the three-month periods ended March 31, 2014, and 2013.

Victory Capital Management and Victory Capital Advisors. On July 31, 2013, we completed the sale of Victory to a private equity fund. As a result of this sale, we recorded an after-tax gain of $92 million as of September 30, 2013. The cash portion of the gain was $72 million as of September 30, 2013. 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:


	Three months ended March 31,
in millions	2014		2013
Net interest income	$	1		—
Noninterest income		10	$	29
Noninterest expense		—		21

Income (loss) before income taxes		11		8
Income taxes		4		3

Income (loss) from discontinued operations, net of taxes	$	7	$	5

The discontinued assets and liabilities of Victory included on the balance sheet are as follows:


in millions	March 31, 2014		December 31, 2013		March 31, 2013
Cash and due from banks		—		—	$	1
Seller note	$	28	$	29		—
Accrued income and other assets		—		—		43

Total assets	$	28	$	29	$	44


Accrued expense and other liabilities		—		—	$	24

Total liabilities		—		—	$	24

The only remaining asset of Victory is a $28 million Seller note. The Seller note was accounted for at fair value and classified as a Level 3 asset through December 31, 2013. Since the contingency involving certain fund outflows was resolved, the Seller note was no longer accounted for at fair value subsequent to December 31, 2013.

The following table shows the change in the fair value of the Level 3 Victory Seller note for the three-month period ended March 31, 2014.


in millions	Seller note
Balance at December 31, 2013	$	29
Gains (losses) recognized in earnings ^(a)		(1	)
Settlements		(28	)

Balance at March 31, 2014 ^(b)		—

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

(b)	There were no purchases, sales, issuances, transfers into Level 3, or transfers out of Level 3 for the three-month period ended March 31, 2014.

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.


	Three months ended March 31,
in millions	2014			2013
Noninterest expense	$	4			—

Income (loss) before income taxes		(4	)		—
Income taxes		(2	)	$	2

Income (loss) from discontinued operations, net of taxes	$	(2	)	$	(2	)

The discontinued assets and liabilities of Austin included on the balance sheet are as follows:


in millions	March 31, 2014		December 31, 2013		March 31, 2013
Cash and due from banks	$	19	$	20	$	22

Total assets	$	19	$	20	$	22


Accrued expense and other liabilities	$	3		—	$	1

Total liabilities	$	3		—	$	1

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


	Three months ended March 31,
in millions	2014			2013
Net interest income	$	24		$	28
Provision (credit) for loan and lease losses		4			6

Net interest income (expense) after provision for loan and lease losses		20			22
Noninterest income		(4	)		13
Noninterest expense		10			28

Income (loss) before income taxes		6			7
Income taxes		2			4

Income (loss) from discontinued operations, net of taxes ^(a)	$	4		$	3

(a)	Includes after-tax charges of $9 million and $10 million for the three months ended March 31, 2014, and 2013, 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:


in millions	March 31, 2014		December 31, 2013		March 31, 2013
Cash and due from banks	$	19	$	20	$	23
Seller note		28		29		—
Trust loans at fair value		1,893		1,960		2,333
Portfolio loans at fair value		143		147		154
Loans, net of unearned income of ($6), ($6), and ($5)		2,318		2,390		2,599
Less: Allowance for loan and lease losses		34		39		49

Net loans		4,320		4,458		5,037
Trust accrued income and other assets at fair value		19		20		25
Accrued income and other assets		41		45		97

Total assets	$	4,427	$	4,572	$	5,182


Trust accrued expense and other liabilities at fair value	$	20	$	20	$	25
Accrued expense and other liabilities		3		—		25
Trust securities at fair value		1,796		1,834		2,126

Total liabilities	$	1,819	$	1,854	$	2,176