KeyCorp 10-Q
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Form 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2007
or
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From                      To                     
Commission File Number 1-11302
    (KEYCORP)    
(Exact name of registrant as specified in its charter)
     
Ohio   34-6542451
     
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
127 Public Square, Cleveland, Ohio   44114-1306
     
(Address of principal executive offices)   (Zip Code)
(216) 689-6300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
     
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Common Shares with a par value of $1 each   388,768,905
     
(Title of class)   (Outstanding at October 31, 2007)
 
 

 


 

KEYCORP
TABLE OF CONTENTS
         
PART I. FINANCIAL INFORMATION
 
        Page Number
   
 
   
Item 1.      
   
 
   
      3
   
 
   
      4
   
 
   
      5
   
 
   
      6
   
 
   
      7
   
 
   
      34
   
 
   
Item 2.     35
   
 
   
Item 3.     75
   
 
   
Item 4.     75
   
 
   
PART II. OTHER INFORMATION
   
 
   
Item 1.     75
   
 
   
Item 2.     75
   
 
   
Item 6.     75
   
 
   
      76
   
 
   
   
Exhibits
  77
 EX-15
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
                         
    September 30,     December 31,     September 30,  
dollars in millions   2007     2006     2006  
    (Unaudited)             (Unaudited)  
ASSETS
                       
Cash and due from banks
  $ 2,016     $ 2,264     $ 2,957  
Short-term investments
    1,723       1,407       1,582  
Securities available for sale
    7,915       7,827       7,441  
Investment securities (fair value: $36, $42 and $42)
    36       41       41  
Other investments
    1,509       1,352       1,367  
Loans, net of unearned income of $2,227, $2,136 and $2,075
    68,999       65,826       65,551  
Less: Allowance for loan losses
    955       944       944  
 
Net loans
    68,044       64,882       64,607  
Loans held for sale
    4,791       3,637       7,150  
Premises and equipment
    631       595       567  
Operating lease assets
    1,135       1,124       1,076  
Goodwill
    1,202       1,202       1,372  
Other intangible assets
    105       120       127  
Corporate-owned life insurance
    2,845       2,782       2,754  
Derivative assets
    1,497       1,091       915  
Accrued income and other assets
    3,917       4,013       4,199  
 
Total assets
  $ 97,366     $ 92,337     $ 96,155  
 
                 
 
                       
LIABILITIES
                       
Deposits in domestic offices:
                       
NOW and money market deposit accounts
  $ 24,198     $ 24,340     $ 25,150  
Savings deposits
    1,544       1,642       1,672  
Certificates of deposit ($100,000 or more)
    6,672       5,941       5,734  
Other time deposits
    11,403       11,956       11,848  
 
Total interest-bearing deposits
    43,817       43,879       44,404  
Noninterest-bearing deposits
    14,003       13,553       13,396  
Deposits in foreign office — interest-bearing
    5,894       1,684       3,629  
 
Total deposits
    63,714       59,116       61,429  
Federal funds purchased and securities sold under repurchase agreements
    5,398       3,643       4,701  
Bank notes and other short-term borrowings
    2,743       1,192       2,594  
Derivative liabilities
    1,063       922       844  
Accrued expense and other liabilities
    5,079       5,228       4,986  
Long-term debt
    11,549       14,533       13,654  
 
Total liabilities
    89,546       84,634       88,208  
 
                       
SHAREHOLDERS’ EQUITY
                       
Preferred stock, $1 par value; authorized 25,000,000 shares, none issued
                 
Common shares, $1 par value; authorized 1,400,000,000 shares; issued 491,888,780 shares
    492       492       492  
Capital surplus
    1,617       1,602       1,588  
Retained earnings
    8,788       8,377       8,371  
Treasury stock, at cost (103,180,446, 92,735,595 and 89,140,338 shares)
    (3,023 )     (2,584 )     (2,434 )
Accumulated other comprehensive loss
    (54 )     (184 )     (70 )
 
Total shareholders’ equity
    7,820       7,703       7,947  
 
Total liabilities and shareholders’ equity
  $ 97,366     $ 92,337     $ 96,155  
 
                 
 
See Notes to Consolidated Financial Statements (Unaudited).

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Consolidated Statements of Income (Unaudited)
                                 
    Three months ended     Nine months ended
    September 30,     September 30,
dollars in millions, except per share amounts   2007     2006     2007     2006  
 
INTEREST INCOME
                               
Loans
  $ 1,209     $ 1,178     $ 3,546     $ 3,374  
Loans held for sale
    91       94       248       235  
Investment securities
          1       1       2  
Securities available for sale
    106       84       312       251  
Short-term investments
    16       16       50       47  
Other investments
    12       16       40       58  
 
Total interest income
    1,434       1,389       4,197       3,967  
 
                               
INTEREST EXPENSE
                               
Deposits
    482       428       1,362       1,136  
Federal funds purchased and securities sold under repurchase agreements
    55       30       163       70  
Bank notes and other short-term borrowings
    30       24       59       75  
Long-term debt
    173       202       554       583  
 
Total interest expense
    740       684       2,138       1,864  
 
 
                               
NET INTEREST INCOME
    694       705       2,059       2,103  
Provision for loan losses
    69       35       166       97  
 
Net interest income after provision for loan losses
    625       670       1,893       2,006  
 
                               
NONINTEREST INCOME
                               
Trust and investment services income
    119       137       359       411  
Service charges on deposit accounts
    88       78       247       227  
Investment banking and capital markets income
    9       44       105       161  
Operating lease income
    70       58       200       166  
Letter of credit and loan fees
    51       48       134       133  
Corporate-owned life insurance income
    27       23       84       74  
Electronic banking fees
    25       27       74       78  
Net gains (losses) from loan securitizations and sales
    (53 )     14       (11 )     34  
Net securities gains (losses)
    4       (7 )     (41 )     (2 )
Gain on sale of McDonald Investments branch network
                171        
Other income
    98       121       419       287  
 
Total noninterest income
    438       543       1,741       1,569  
 
                               
NONINTEREST EXPENSE
                               
Personnel
    383       418       1,222       1,245  
Net occupancy
    60       62       182       182  
Computer processing
    49       52       149       157  
Operating lease expense
    58       48       165       134  
Professional fees
    27       28       79       101  
Equipment
    22       26       71       78  
Marketing
    21       32       60       70  
Other expense
    133       124       424       373  
 
Total noninterest expense
    753       790       2,352       2,340  
 
                               
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE
    310       423       1,282       1,235  
Income taxes
    86       118       363       353  
 
INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
    224       305       919       882  
(Loss) income from discontinued operations, net of taxes of ($8), $4, ($15) and $14, respectively (see Note 3)
    (14 )     7       (25 )     22  
 
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
    210       312       894       904  
Cumulative effect of accounting change, net of taxes (see Note 1)
                      5  
 
NET INCOME
  $ 210     $ 312     $ 894     $ 909  
 
                       
 
                               
Per common share:
                               
Income from continuing operations before cumulative effect of accounting change
  $ .58     $ .76     $ 2.34     $ 2.18  
Income before cumulative effect of accounting change
    .54       .77       2.28       2.23  
Net income
    .54       .77       2.28       2.24  
Per common share — assuming dilution:
                               
Income from continuing operations before cumulative effect of accounting change
  $ .57     $ .74     $ 2.31     $ 2.15  
Income before cumulative effect of accounting change
    .54       .76       2.25       2.20  
Net income
    .54       .76       2.25       2.21  
Cash dividends declared per common share
  $ .365     $ .345     $ 1.095     $ 1.035  
Weighted-average common shares outstanding (000)
    389,319       403,780       393,048       405,218  
Weighted-average common shares and potential common shares outstanding (000)
    393,164       409,428       397,816       411,029  
 
See Notes to Consolidated Financial Statements (Unaudited).

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Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
                                                         
                                            Accumulated        
                                    Treasury     Other        
    Common Shares     Common     Capital     Retained     Stock,     Comprehensive     Comprehensive  
dollars in millions, except per share amounts   Outstanding (000)     Shares     Surplus     Earnings     at Cost     Loss     Income  
 
BALANCE AT DECEMBER 31, 2005
    406,624     $ 492     $ 1,534     $ 7,882     $ (2,204 )   $ (106 )        
Net income
                            909                     $ 909  
Other comprehensive income (losses):
                                                       
Net unrealized gains on securities available for sale, net of income taxes of $5a
                                            6       6  
Net unrealized gains on derivative financial instruments, net of income taxes
                                            1       1  
Net unrealized losses on common investments held in employee welfare benefits trust, net of income taxes
                                            (1 )     (1 )
Foreign currency translation adjustments
                                            30       30  
 
                                                     
Total comprehensive income
                                                  $ 945  
 
                                                     
Deferred compensation
                    21                                  
Cash dividends declared on common shares ($1.035 per share)
                            (420 )                        
Issuance of common shares for stock options and other employee benefit plans
    8,624               33               227                  
Repurchase of common shares
    (12,500 )                             (457 )                
         
BALANCE AT SEPTEMBER 30, 2006
    402,748     $ 492     $ 1,588     $ 8,371     $ (2,434 )   $ (70 )        
 
                                           
         
BALANCE AT DECEMBER 31, 2006
    399,153     $ 492     $ 1,602     $ 8,377     $ (2,584 )   $ (184 )        
Cumulative effect of adopting FSP 13-2,
net of income taxes of ($2)
(see Note 1)
                            (52 )                        
Cumulative effect of adopting FIN 48,
net of income taxes of ($1) (see Note 1)
                            (1 )                        
 
                                                     
BALANCE AT JANUARY 1, 2007
                            8,324                          
Net income
                            894                     $ 894  
Other comprehensive income:
                                                       
Net unrealized gains on securities available for sale, net of income taxes of $31a
                                            50       50  
Net unrealized gains on derivative financial instruments, net of income taxes of $25
                                            42       42  
Foreign currency translation adjustments
                                            23       23  
Net pension and postretirement benefit costs, net of income taxes
                                            15       15  
 
                                                     
Total comprehensive income
                                                  $ 1,024  
 
                                                     
Deferred compensation
                    12       (3 )                        
Cash dividends declared on common shares ($1.095 per share)
                            (427 )                        
Issuance of common shares for stock options and other employee benefit plans
    5,555               3               156                  
Repurchase of common shares
    (16,000 )                             (595 )                
         
BALANCE AT SEPTEMBER 30, 2007
    388,708     $ 492     $ 1,617     $ 8,788     $ (3,023 )   $ (54 )        
 
                                           
         
(a)   Net of reclassification adjustments.
See Notes to Consolidated Financial Statements (Unaudited).

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Consolidated Statements of Cash Flows (Unaudited)
                 
    Nine months ended
    September 30,
in millions   2007     2006  
 
OPERATING ACTIVITIES
               
Net income
  $ 894     $ 909  
Adjustments to reconcile net income to net cash used in operating activities:
               
Provision for loan losses
    166       94  
Depreciation and amortization expense
    316       292  
Litigation reserve
    42        
Net securities losses
    41       2  
Gain from sale of McDonald Investments branch network
    (171 )      
Gains related to MasterCard Incorporated shares
    (67 )     (9 )
Proceeds from settlement of automobile residual value insurance litigation
    279        
Gain from settlement of automobile residual value insurance litigation
    (26 )      
Net gains from principal investing
    (128 )     (48 )
Net gains (losses) from loan securitizations and sales
    11       (34 )
Loss from sale of discontinued operations
    2        
Deferred income taxes
    (53 )     (230 )
Net increase in loans held for sale
    (1,154 )     (1,295 )
Net (increase) decrease in trading account assets
    (148 )     33  
Other operating activities, net
    (603 )     (232 )
 
NET CASH USED IN OPERATING ACTIVITIES
    (599 )     (518 )
INVESTING ACTIVITIES
               
Cash used in acquisitions, net of cash acquired
          (34 )
Proceeds from sale of McDonald Investments branch network, net of retention payments
    199        
Proceeds from sale of MasterCard Incorporated shares
    67       9  
Net increase in other short-term investments
    (168 )     (23 )
Purchases of securities available for sale
    (4,333 )     (2,730 )
Proceeds from sales of securities available for sale
    2,506       154  
Proceeds from prepayments and maturities of securities available for sale
    1,788       2,421  
Purchases of investment securities
          (2 )
Proceeds from prepayments and maturities of investment securities
    5       53  
Purchases of other investments
    (500 )     (401 )
Proceeds from sales of other investments
    275       189  
Proceeds from prepayments and maturities of other investments
    138       209  
Net increase in loans, excluding acquisitions, sales and transfers
    (3,723 )     (1,990 )
Purchases of loans
    (61 )     (64 )
Proceeds from loan securitizations and sales
    306       298  
Purchases of premises and equipment
    (123 )     (68 )
Proceeds from sales of premises and equipment
    9       4  
Proceeds from sales of other real estate owned
    61       20  
 
NET CASH USED IN INVESTING ACTIVITIES
    (3,554 )     (1,955 )
FINANCING ACTIVITIES
               
Net increase in deposits
    4,594       2,674  
Net increase in short-term borrowings
    3,306       680  
Net proceeds from issuance of long-term debt
    393       1,609  
Payments on long-term debt
    (3,490 )     (1,997 )
Purchases of treasury shares
    (595 )     (457 )
Net proceeds from issuance of common stock
    111       207  
Tax benefits in excess of recognized compensation cost for stock-based awards
    13       26  
Cash dividends paid
    (427 )     (420 )
 
NET CASH PROVIDED BY FINANCING ACTIVITIES
    3,905       2,322  
 
NET DECREASE IN CASH AND DUE FROM BANKS
    (248 )     (151 )
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD
    2,264       3,108  
 
CASH AND DUE FROM BANKS AT END OF PERIOD
  $ 2,016     $ 2,957  
 
           
 
Additional disclosures relative to cash flows:
               
Interest paid
  $ 2,211     $ 2,042  
Income taxes paid
    276       328  
Noncash items:
               
Loans transferred from portfolio to held for sale
        $ 2,474  
Loans transferred to other real estate owned
  $ 31       52  
 
See Notes to Consolidated Financial Statements (Unaudited).

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Notes to Consolidated Financial Statements (Unaudited)
1. Basis of Presentation
The unaudited condensed consolidated interim financial statements include the accounts of KeyCorp and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
As used in these Notes, KeyCorp refers solely to the parent company and Key refers to the consolidated entity consisting of KeyCorp and its subsidiaries.
The consolidated financial statements include any voting rights entity in which Key has a controlling financial interest. In accordance with Financial Accounting Standards Board (“FASB”) Revised Interpretation No. 46, “Consolidation of Variable Interest Entities,” a variable interest entity (“VIE”) is consolidated if Key has a variable interest in the entity and is exposed to the majority of its expected losses and/or residual returns (i.e., Key is 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 8 (“Variable Interest Entities”) on page 22 for information on Key’s involvement with VIEs.
Management uses the equity method to account for unconsolidated investments in voting rights entities or VIEs in which Key has significant influence over operating and financing decisions (usually defined as a voting or economic interest of 20% to 50%, but not a controlling interest). Unconsolidated investments in voting rights entities or VIEs in which Key has a voting or economic interest of less than 20% generally are carried at cost. Investments held by KeyCorp’s registered broker/dealer and investment company subsidiaries (primarily principal investments) are carried at estimated fair value.
Qualifying special purpose entities (“SPEs”), including securitization trusts, established by Key under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” are not consolidated. Information on SFAS No. 140 is included in Note 1 (“Summary of Significant Accounting Policies”) of Key’s 2006 Annual Report to Shareholders under the heading “Loan Securitizations” on page 69.
Management believes that the unaudited condensed 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. Some previously reported results have been reclassified to conform to current reporting practices.
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 Key’s 2006 Annual Report to Shareholders.
Servicing Assets
Key’s servicing assets, which totaled $352 million at September 30, 2007, $282 million at December 31, 2006, and $263 million at September 30, 2006, are included in “accrued income and other assets” on the balance sheet. Key services both mortgage and education loans. Servicing assets at September 30, 2007, include $322 million related to mortgage loan servicing and $30 million related to education loan servicing.
Effective January 1, 2007, Key adopted SFAS No. 156, “Accounting for Servicing of Financial Assets – an Amendment of FASB Statement No. 140,” which requires that newly purchased or retained servicing assets and liabilities be initially measured at fair value, if practicable. SFAS No. 156 also requires the subsequent remeasurement of servicing assets and liabilities at each reporting date using one of two methods: amortization over the servicing period or measurement at fair value.

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When no ready market value such as quoted market prices or prices based on sales or purchases of similar assets is available to determine the fair value of servicing assets, the fair value is determined by estimating the present value of future cash flows associated with servicing the loans. The estimate is based on a number of assumptions, including the cost of servicing, discount rate, prepayment rate and default rate.
Key has elected to subsequently remeasure servicing assets using the amortization method. The amortization of servicing assets is determined in proportion to, and over the period of, the estimated net servicing income and is recorded in “other income” on the income statement.
In accordance with SFAS No. 140, the initial value of servicing assets purchased or retained prior to January 1, 2007, was determined by allocating the amount of the assets sold or securitized to the retained interests and the assets sold based on their relative fair values at the date of transfer. These servicing assets are reported at the lower of amortized cost or fair value.
Servicing assets are evaluated quarterly for possible impairment by classifying the assets based on the types of loans serviced and their associated interest rates, and estimating the fair value of each class. If the evaluation indicates that the carrying amount of the servicing assets exceeds their fair value, the carrying amount is reduced through a charge to income in the amount of such excess. For the nine-month periods ended September 30, 2007 and 2006, no servicing asset impairment occurred. Additional information pertaining to servicing assets is included in Note 7 (“Mortgage Servicing Assets”), which begins on page 21.
Stock-Based Compensation
Effective January 1, 2006, Key adopted SFAS No. 123R, “Share-Based Payment,” which replaced SFAS No. 123. SFAS 123R requires stock-based compensation to be measured using the fair value method of accounting, with the measured cost to be recognized over the period during which the recipient is required to provide service in exchange for the award. SFAS No. 123R also changes the manner of accounting for forfeited stock-based awards. Under the new standard, companies are no longer permitted to account for forfeitures as they occur. Instead, companies that had been using this alternative method of accounting for forfeitures must now estimate expected forfeitures at the date the awards are granted and record compensation expense only for those that are expected to vest. As of the effective date, companies had to estimate expected forfeitures and reduce their related compensation obligation for expense previously recognized in the financial statements. The after-tax amount of this reduction is presented on the income statement as a cumulative effect of a change in accounting principle. Key’s cumulative after-tax adjustment increased first quarter 2006 earnings by $5 million, or $.01 per diluted common share.
Accounting Pronouncements Adopted in 2007
Accounting for leveraged leases. In July 2006, the FASB issued Staff Position No. 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction,” which provides additional guidance on the application of SFAS No. 13, “Accounting for Leases.” This guidance affects when earnings from leveraged lease transactions will be recognized, and requires a lessor to recalculate its recognition of lease income when there are changes or projected changes in the timing of cash flows, including changes due to final or expected settlements of tax matters. Previously, leveraged lease transactions were required to be recalculated only when a change in the total projected net income from the lease occurred. This guidance became effective for fiscal years beginning after December 15, 2006 (effective January 1, 2007, for Key).
Adoption of this guidance resulted in a cumulative after-tax charge of $52 million to Key’s retained earnings. Future earnings are expected to increase over the remaining term of the affected leases by a similar amount. Additional information related to Staff Position No. 13-2 is included in Note 12 (“Income Taxes”) under the heading “Tax-Related Accounting Pronouncements Adopted in 2007” on page 26.

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Accounting for uncertain tax positions. In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” which clarifies the application of SFAS No. 109, “Accounting for Income Taxes,” by defining the minimum threshold that a tax position must meet for the associated tax benefit to be recognized in a company’s financial statements. It also provides guidance on measurement and derecognition of tax benefits, and requires expanded disclosures. The interpretation became effective for fiscal years beginning after December 15, 2006 (effective January 1, 2007, for Key). Adoption of this guidance did not have a material impact on Key’s financial condition or results of operations. Additional information related to this interpretation is included in Note 12 under the heading “Tax-Related Accounting Pronouncements Adopted in 2007.”
Accounting for servicing of financial assets. As discussed under the heading “Servicing Assets” on page 7, effective January 1, 2007, Key adopted SFAS No. 156, which requires that servicing assets and liabilities be initially measured at fair value, if practicable. SFAS No. 156 also requires the subsequent remeasurement of servicing assets and liabilities at each reporting date using one of two methods: amortization over the servicing period or measurement at fair value. Adoption of this guidance did not have a material effect on Key’s financial condition or results of operations. Additional information related to SFAS No. 156 is included in Note 7.
Accounting for certain hybrid financial instruments. In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments.” A hybrid financial instrument is one in which a derivative is embedded in another financial instrument. SFAS No. 155 permits fair value measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require the financial instrument and derivative to be separated. This guidance eliminates the prohibition on a qualifying SPE from holding certain derivative financial instruments. SFAS No. 155 became effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006 (effective January 1, 2007, for Key). Adoption of this guidance did not have a material effect on Key’s financial condition or results of operations.
Accounting Pronouncements Pending Adoption
Accounting for investment companies. In June 2007, the Accounting Standards Executive Committee, under the auspices of the FASB, issued Statement of Position (“SOP”) No. 07-1, “Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies.” The new pronouncement provides guidance for determining whether an entity is within the scope of the Guide and whether the specialized industry accounting principles of the Guide should be applied by a parent company in accounting for an investment company subsidiary. SOP No. 07-1 will be effective for fiscal years beginning on or after December 15, 2007 (effective January 1, 2008, for Key). Management is evaluating the potential effect this guidance may have on Key’s financial condition or results of operations.
Investment companies under Revised Interpretation No. 46. In May 2007, the FASB issued Staff Position FIN 46(R)-7, “Application of FASB Interpretation No. 46(R) to Investment Companies.” The new pronouncement provides an exception to the scope of Revised Interpretation No. 46 for investment companies within the scope of SOP No. 07-1. Staff Position FIN 46(R)-7 will be effective for fiscal years beginning on or after December 15, 2007 (effective January 1, 2008, for Key). Management is evaluating the potential effect this guidance may have on Key’s financial condition or results of operations.
Fair value option for financial assets and financial liabilities. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This guidance provides an option to selectively report financial assets and liabilities at fair value, and establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 will be effective for fiscal years beginning after November 15, 2007 (effective January 1, 2008, for Key). Management is evaluating whether this fair value option will be used for any of Key’s financial assets or liabilities, and the resulting effect on Key’s financial condition or results of operations.

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Fair value measurements. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This guidance applies only when other guidance requires or permits assets or liabilities to be measured at fair value; it does not expand the use of fair value in any new
circumstances. SFAS No. 157 will be effective for fiscal years beginning after November 15, 2007 (effective January 1, 2008, for Key). Management is evaluating the potential effect this guidance may have on Key’s financial condition or results of operations.
Employers’ accounting for defined benefit pension and other postretirement plans. In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” Except for the measurement requirement, Key adopted this accounting guidance as of December 31, 2006. Additional information regarding the adoption of SFAS No. 158 is included in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Accounting Pronouncements Adopted in 2006” on page 72 of Key’s 2006 Annual Report to Shareholders. The requirement to measure plan assets and benefit obligations as of the end of an employer’s fiscal year is effective for years ending after December 15, 2008 with earlier application encouraged (no later than December 31, 2008, for Key). Adoption of this guidance is not expected to have a material effect on Key’s financial condition or results of operations.
2. Earnings per Common Share
Key’s basic and diluted earnings per common share are calculated as follows:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
dollars in millions, except per share amounts   2007     2006     2007     2006  
 
EARNINGS
                               
Income from continuing operations before cumulative effect of accounting change
  $ 224     $ 305     $ 919     $ 882  
(Loss) income from discontinued operations, net of taxes
    (14 )     7       (25 )     22  
Income before cumulative effect of accounting change
    210       312       894       904  
Net income
    210       312       894       909  
 
WEIGHTED-AVERAGE COMMON SHARES
                               
Weighted-average common shares outstanding (000)
    389,319       403,780       393,048       405,218  
Effect of dilutive common stock options and other stock awards (000)
    3,845       5,648       4,768       5,811  
 
Weighted-average common shares and potential common shares outstanding (000)
    393,164       409,428       397,816       411,029  
 
                       
 
EARNINGS PER COMMON SHARE
                               
Income per common share from continuing operations before cumulative effect of accounting change
  $ .58     $ .76     $ 2.34     $ 2.18  
(Loss) income per common share from discontinued operations
    (.03 )     .02       (.06 )     .05  
Income per common share before cumulative effect of accounting change
    .54       .77       2.28       2.23  
Net income per common share
    .54       .77       2.28       2.24  
 
                               
Income per common share from continuing operations before cumulative effect of accounting change — assuming dilution
  $ .57     $ .74     $ 2.31     $ 2.15  
(Loss) income per common share from discontinued operations — assuming dilution
    (.03 )     .02       (.06 )     .05  
Income per common share before cumulative effect of accounting
change — assuming dilution
    .54       .76       2.25       2.20  
Net income per common share — assuming dilution
    .54       .76       2.25       2.21  
 

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3. Acquisitions and Divestitures
Acquisitions and divestitures either completed by Key during 2006 and the first nine months of 2007, or pending completion, are summarized below.
Acquisitions
Tuition Management Systems, Inc.
On October 1, 2007, Key acquired Tuition Management Systems, Inc., one of the nation’s largest providers of outsourced tuition planning, billing, counseling and payment services. Headquartered in Warwick, Rhode Island, Tuition Management Systems serves more than 700 colleges, universities, elementary and secondary educational institutions. The terms of the acquisition were not material.
Austin Capital Management, Ltd.
On April 1, 2006, Key acquired Austin Capital Management, Ltd., an investment firm headquartered in Austin, Texas with approximately $900 million in assets under management at the date of acquisition. Austin specializes in selecting and managing hedge fund investments for its principally institutional customer base. The terms of the acquisition were not material.
Divestitures
Champion Mortgage
On February 28, 2007, Key sold the Champion Mortgage loan origination platform to an affiliate of Fortress Investment Group LLC, a global alternative investment and asset management firm, for cash proceeds of $.5 million.
On November 29, 2006, Key sold the nonprime mortgage loan portfolio held by the Champion Mortgage finance business to a wholly-owned subsidiary of HSBC Finance Corporation for cash proceeds of $2.5 billion. The loan portfolio totaled $2.5 billion at the date of sale.
As a result of these actions, Key has applied discontinued operations accounting to this business for all periods presented in this report. The results of the discontinued Champion Mortgage finance business are presented on one line as “(loss) income from discontinued operations, net of taxes” in the Consolidated Statements of Income on page 4. The components of (loss) income from discontinued operations are as follows:
                                 
    Three months ended     Nine months ended
    September 30,     September 30,
in millions   2007     2006     2007     2006  
 
(Loss) income, net of taxes of ($2), $4, ($5) and $14, respectively a
  $ (3 )   $ 7     $ (9 )   $ 22  
Loss on disposal, net of taxes of ($1)
                (1 )      
Disposal transaction costs, net of taxes of ($6) and ($9), respectively b
    (11 )           (15 )      
 
(Loss) income from discontinued operations
  $ (14 )   $ 7     $ (25 )   $ 22  
 
                       
 
(a)   Includes after-tax charges of $.06 million and $19 million for the three-month periods ended September 30, 2007 and 2006, respectively, and $.7 million and $54 million for the nine-month periods ended September 30, 2007 and 2006, respectively, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support Champion’s operations.
 
(b)   Disposal transaction costs were attributable largely to a write-down on the building lease for the former Champion headquarters recorded during the third quarter of 2007.

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The discontinued assets and liabilities of Champion Mortgage included in the Consolidated Balance Sheets on page 3 are as follows:
                         
    September 30,     December 31,     September 30,  
in millions   2007     2006     2006  
 
Loans
  $ 9     $ 10     $ 11  
Loans held for sale
          179       2,484  
Accrued income and other assets
    2       22       230  
 
Total assets
  $ 11     $ 211     $ 2,725  
 
                 
 
                       
Deposits
        $ 88     $ 8  
Accrued expense and other liabilities
  $ 14       17       5  
 
Total liabilities
  $ 14     $ 105     $ 13  
 
                 
 
McDonald Investments branch network
On February 9, 2007, McDonald Investments Inc., a wholly-owned subsidiary of KeyCorp, sold its branch network, which included approximately 570 financial advisors and field support staff, and certain fixed assets, to UBS Financial Services Inc., a subsidiary of UBS AG. Key received cash proceeds of $219 million and recorded a gain of $171 million ($107 million after tax, $.26 per diluted common share) in connection with the sale. Key retained the corporate and institutional businesses, including Institutional Equities and Equity Research, Debt Capital Markets and Investment Banking. In addition, KeyBank National Association (“KeyBank”), KeyCorp’s subsidiary bank, continues to conduct its Wealth Management, Trust and Private Banking businesses. On April 16, 2007, Key renamed its registered broker/dealer through which its corporate and institutional investment banking and securities businesses operate. The new name is KeyBanc Capital Markets Inc.
Acquisition Pending
U.S.B. Holding Co., Inc.
On July 26, 2007, Key entered into a definitive agreement to acquire U.S.B. Holding Co., Inc., the holding company for Union State Bank, a state-chartered commercial bank headquartered in Orangeburg, New York, with 31 branches. U.S.B. Holding Co. has assets of approximately $3 billion and deposits of approximately $2 billion. Under the terms of the agreement, each share of U.S.B. Holding Co. common stock will be exchanged at the closing for .455 KeyCorp common shares and $8.925 in cash. Based on the closing price of KeyCorp common shares on July 26, 2007 (the last trading day preceding the announcement of the agreement), the transaction would be valued at approximately $575 million. The transaction is expected to close early in 2008, subject to approval by U.S.B. Holding Co. shareholders and the banking regulators. After the close, Key plans to merge Union State Bank into KeyBank. The acquisition will expand Key’s presence in markets both within and contiguous to its current operations in the Hudson Valley.

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4. Line of Business Results
Community Banking
Regional Banking provides individuals with branch-based deposit and investment products, personal finance services and loans, including residential mortgages, home equity and various types of installment loans. This line of business also provides small businesses with deposit, investment and credit products, and business advisory services.
Regional Banking also offers financial, estate and retirement planning, and asset management services to assist high-net-worth clients with their banking, trust, portfolio management, insurance, charitable giving and related needs.
Commercial Banking provides midsize businesses with products and services that include commercial lending, cash management, equipment leasing, investment and employee benefit programs, succession planning, access to capital markets, derivatives and foreign exchange.
National Banking
Real Estate Capital provides construction and interim lending, permanent debt placements and servicing, and equity and investment banking services to developers, brokers and owner-investors. This line of business deals exclusively with nonowner-occupied properties (i.e., generally properties in which at least 50% of the debt service is provided by rental income from nonaffiliated third parties).
Equipment Finance meets the equipment leasing needs of companies worldwide and provides equipment manufacturers, distributors and resellers with financing options for their clients. Lease financing receivables and related revenues are assigned to other lines of business (primarily Institutional and Capital Markets, and Commercial Banking) if those businesses are principally responsible for maintaining the relationship with the client.
Institutional and Capital Markets provides products and services to large corporations, middle-market companies, financial institutions, government entities and not-for-profit organizations. These products and services include commercial lending, treasury management, investment banking, derivatives and foreign exchange, equity and debt underwriting and trading, and syndicated finance.
Through its Victory Capital Management unit, Institutional and Capital Markets also manages or gives advice regarding investment portfolios for a national client base, including corporations, labor unions, not-for-profit organizations, governments and individuals. These portfolios may be managed in separate accounts, common funds or the Victory family of mutual funds.
Consumer Finance includes Indirect Lending, Commercial Floor Plan Lending, Home Equity Services and Business Services.
Indirect Lending offers loans to consumers through dealers. This business unit also provides federal and private education loans to students and their parents, and processes payments on loans that private schools make to parents.
Commercial Floor Plan Lending finances inventory for automobile and marine dealers.
Home Equity Services works with home improvement contractors to provide home equity and home improvement financing solutions.
Business Services provides payroll processing solutions for businesses of all sizes.
Other Segments
Other Segments consist of Corporate Treasury and Key’s Principal Investing unit.

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Reconciling Items
Total assets included under “Reconciling Items” primarily represent the unallocated portion of nonearning assets of corporate support functions. Charges related to the funding of these assets are part of net interest income and are allocated to the business segments through noninterest expense. Reconciling Items also includes intercompany eliminations and certain items that are not allocated to the business segments because they do not reflect their normal operations.
The table that spans pages 15 and 16 shows selected financial data for each major business group for the three- and nine-month periods ended September 30, 2007 and 2006. This table is accompanied by supplementary information for each of the lines of business that make up these groups. The information was derived from the internal financial reporting system that management uses to monitor and manage Key’s financial performance. U.S. generally accepted accounting principles (“GAAP”) guide financial accounting, but there is no authoritative guidance for “management accounting”—the way management uses its judgment and experience to make reporting decisions. Consequently, the line of business results Key reports may not be comparable with line of business results presented by other companies.
The selected financial data are based on internal accounting policies designed to compile results on a consistent basis and in a manner that reflects the underlying economics of the businesses. According to Key’s policies:
¨   Net interest income is determined by assigning a standard cost for funds used or a standard credit for funds provided based on their assumed maturity, prepayment and/or repricing characteristics. The net effect of this funds transfer pricing is charged to the lines of business based on the total loan and deposit balances of each line.
 
¨   Indirect expenses, such as computer servicing costs and corporate overhead, are allocated based on assumptions regarding the extent to which each line actually uses the services.
 
¨   Key’s consolidated provision for loan losses is allocated among the lines of business primarily based on their actual net charge-offs, adjusted periodically for loan growth and changes in risk profile. The level of the consolidated provision is based on the methodology that management uses to estimate Key’s consolidated allowance for loan losses. This methodology is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan Losses” on page 69 of Key’s 2006 Annual Report to Shareholders.
 
¨   Income taxes are allocated based on the statutory federal income tax rate of 35% (adjusted for tax-exempt interest income, income from corporate-owned life insurance and tax credits associated with investments in low-income housing projects) and a blended state income tax rate (net of the federal income tax benefit) of 2.5%.
 
¨   Capital is assigned based on management’s assessment of economic risk factors (primarily credit, operating and market risk) directly attributable to each line.
Developing and applying the methodologies that management uses to allocate items among Key’s lines of business is a dynamic process. Accordingly, financial results may be revised periodically to reflect accounting enhancements, changes in the risk profile of a particular business or changes in Key’s organizational structure.
Effective January 1, 2007, Key reorganized the following business units within its lines of business:
¨   The Mortgage Services unit, previously included under the Consumer Finance line of business within the National Banking group, has been moved to the Regional Banking line of business within the Community Banking group.
 
¨   In light of the Champion divestiture, the National Home Equity unit, previously included under the Consumer Finance line of business within the National Banking group, has been eliminated and replaced by the remaining Home Equity Services unit.
 
¨   Business Services has been added as a unit under the Consumer Finance line of business within the National Banking group.

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Three months ended September 30,   Community Banking     National Banking     Other Segments
dollars in millions   2007     2006     2007     2006     2007     2006  
 
SUMMARY OF OPERATIONS
                                               
Net interest income (TE)
  $ 409     $ 443     $ 359     $ 348     $ (24 )   $ (31 )
Noninterest income
    217       244       152       238       38       56  
 
Total revenue (TE) a
    626       687       511       586       14       25  
Provision for loan losses
    1       22       68       13              
Depreciation and amortization expense
    34       37       73       62              
Other noninterest expense
    383       449       255       242       6       7  
 
Income (loss) from continuing operations before income taxes (TE)
    208       179       115       269       8       18  
Allocated income taxes and TE adjustments
    77       67       43       100       (8 )     (2 )
 
Income from continuing operations
    131       112       72       169       16       20  
(Loss) income from discontinued operations, net of taxes
                (14 )     7              
 
Net income
  $ 131     $ 112     $ 58     $ 176     $ 16     $ 20  
 
                                   
 
                                               
Percent of consolidated income from continuing operations
    59 %     37 %     32 %     55 %     7 %     7 %
Percent of total segments income from continuing operations
    60       37       33       56       7       7  
 
AVERAGE BALANCES b
                                               
Loans and leases
  $ 26,947     $ 26,794     $ 40,277     $ 37,871     $ 245     $ 282  
Total assets a
    29,716       29,871       50,954       48,530       12,523       11,503  
Deposits
    46,727       46,939       12,633       11,106       3,203       2,224  
 
OTHER FINANCIAL DATA
                                               
Net loan charge-offs
  $ 20     $ 21     $ 39     $ 22              
Return on average allocated equityb
    20.77 %     17.73 %     6.90 %     17.27 %     N/M       N/M  
Return on average allocated equity
    20.77       17.73       5.56       16.92       N/M       N/M  
Average full-time equivalent employees
    8,632       9,836       3,841       4,305       43       41  
 
                                                 
Nine months ended September 30,   Community Banking     National Banking     Other Segments
dollars in millions   2007     2006     2007     2006     2007     2006  
 
SUMMARY OF OPERATIONS
                                               
Net interest income (TE)
  $ 1,242     $ 1,309     $ 1,045     $ 1,039     $ (72 )   $ (91 )
Noninterest income
    818 c     714       682 d     709       167 e     129  
 
Total revenue (TE) a
    2,060       2,023       1,727       1,748       95       38  
Provision for loan losses
    36       71       130       26              
Depreciation and amortization expense
    105       112       211       178              
Other noninterest expense
    1,231       1,323       757       734       49 e     21  
 
Income (loss) from continuing operations before income taxes and cumulative effect of accounting change (TE)
    688       517       629       810       46       17  
Allocated income taxes and TE adjustments
    258       194       236       301       (16 )     (22 )
 
Income from continuing operations before cumulative effect of accounting change
    430       323       393       509       62       39  
(Loss) income from discontinued operations, net of taxes
                (25 )     22              
 
Income before cumulative effect of accounting change
    430       323       368       531       62       39  
Cumulative effect of accounting change, net of taxes
                                   
 
Net income
  $ 430     $ 323     $ 368     $ 531     $ 62     $ 39  
 
                                   
 
                                               
Percent of consolidated income from continuing operations
    47 %     37 %     43 %     58 %     6 %     4 %
Percent of total segments income from continuing operations
    49       37       44       59       7       4  
 
AVERAGE BALANCES b
                                               
Loans and leases
  $ 26,661     $ 26,803     $ 39,485     $ 37,545     $ 263     $ 302  
Total assets a
    29,454       29,883       49,665       47,659       12,401       11,456  
Deposits
    46,458       46,459       12,009       10,597       2,575       2,042  
 
OTHER FINANCIAL DATA
                                               
Net loan charge-offs
  $ 65     $ 74     $ 91     $ 42              
Return on average allocated equity b
    23.23 %     17.27 %     12.83 %     17.83 %     N/M       N/M  
Return on average allocated equity
    23.23       17.27       12.02       17.47       N/M       N/M  
Average full-time equivalent employees
    9,043       9,697       3,955       4,235       43       40  
 
(a)   Substantially all revenue generated by Key’s major business groups is derived from clients with residency in the United States. Substantially all long-lived assets, including premises and equipment, capitalized software and goodwill held by Key’s major business groups are located in the United States.
 
(b)   From continuing operations.
 
(c)   Community Banking results for the first nine months of 2007 include a $171 million ($107 million after tax) gain from the February 9, 2007, sale of the McDonald Investments branch network. See Note 3 (“Acquisitions and Divestitures”), which begins on page 11, for more information pertaining to this transaction.
 
(d)   National Banking results for the first nine months of 2007 include a $26 million ($17 million after tax) gain from the settlement of the residual value insurance litigation during the first quarter.
 
(e)   Other Segments’ results for the first nine months of 2007 include a $26 million ($16 million after tax) charge for litigation recorded during the second quarter. This charge and the litigation charge referred to in note (f) below comprise the $42 million charge recorded in connection with the Honsador litigation disclosed in Note 13 (“Contingent Liabilities and Guarantees”), which begins on page 28. Results for the current year-to-date period also include a $49 million ($31 million after tax) loss recorded during the first quarter in connection with the repositioning of the securities portfolio.
 
(f)   Reconciling Items include gains of $27 million ($17 million after tax) recorded during the third quarter of 2007, $40 million ($25 million after tax) recorded during the second quarter of 2007 and $9 million ($6 million after tax) recorded during the second quarter of 2006 related to MasterCard Incorporated shares. Results for the first nine months of 2007 also include a $16 million ($10 million after tax) charge for litigation recorded during the second quarter.
 
TE = Taxable Equivalent, N/A = Not Applicable, N/M = Not Meaningful    

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Table of Contents

                                             
Total Segments     Reconciling Items     Key
2007     2006     2007     2006     2007     2006  
 
                                             
$ 744     $ 760     $ (32 )   $ (34 )   $ 712     $ 726  
  407       538       31 f     5       438       543  
 
  1,151       1,298       (1 )     (29 )     1,150       1,269  
  69       35                   69       35  
  107       99                   107       99  
  644       698       2       (7 )     646       691  
 
                                             
  331       466       (3 )     (22 )     328       444  
                                             
  112       165       (8 )     (26 )     104       139  
 
  219       301       5       4       224       305  
                                             
  (14 )     7                   (14 )     7  
 
$ 205     $ 308     $ 5     $ 4     $ 210     $ 312  
                                 
                                             
                                             
  98 %     99 %     2 %     1 %     100 %     100 %
                                             
  100       100       N/A       N/A       N/A       N/A  
 
                                             
$ 67,469     $ 64,947     $ 211     $ 233     $ 67,680     $ 65,180  
  93,193       89,904       1,969       2,359       95,162       92,263  
  62,563       60,269       (42 )     (229 )     62,521       60,040  
 
                                             
$ 59     $ 43                 $ 59     $ 43  
  12.14 %     17.48 %     N/M       N/M       11.50 %     15.52 %
  11.37       17.27       N/M       N/M       10.79       15.88  
                                             
  12,516       14,182       6,051       6,082       18,567       20,264  
 
                                             
Total Segments     Reconciling Items     Key
2007     2006     2007     2006     2007     2006  
 
                                             
$ 2,215     $ 2,257     $ (97 )   $ (83 )   $ 2,118     $ 2,174  
  1,667       1,552       74 f     17 f     1,741       1,569  
 
  3,882       3,809       (23 )     (66 )     3,859       3,743  
  166       97                   166       97  
  316       290                   316       290  
  2,037       2,078       (1) f     (28 )     2,036       2,050  
 
                                             
                                             
                                             
  1,363       1,344       (22 )     (38 )     1,341       1,306  
                                             
  478       473       (56 )     (49 )     422       424  
 
                                             
                                             
  885       871       34       11       919       882  
                                             
  (25 )     22                   (25 )     22  
 
                                             
  860       893       34       11       894       904  
                                             
                    5             5  
 
$ 860     $ 893     $ 34     $ 16     $ 894     $ 909  
                                 
                                             
                                             
  96 %     99 %     4 %     1 %     100 %     100 %
                                             
  100       100       N/A       N/A       N/A       N/A  
 
                                             
$ 66,409     $ 64,650     $ 153     $ 152     $ 66,562     $ 64,802  
  91,520       88,998       2,048       2,249       93,568       91,247  
  61,042       59,098       (139 )     (162 )     60,903       58,936  
 
                                             
$ 156     $ 116                 $ 156     $ 116  
  16.78 %     17.25 %     N/M       N/M       16.03 %     15.44 %
  16.31       17.06       N/M       N/M       15.59       15.82  
                                             
  13,041       13,972       6,040       6,002       19,081       19,974  
 

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Supplementary Information (Community Banking lines of business)
                                 
Three months ended September 30,   Regional Banking     Commercial Banking
dollars in millions   2007     2006     2007     2006  
 
Total revenue (TE)
  $ 532     $ 587     $ 94     $ 100  
Provision (credit) for loan losses
    12       19       (11 )     3  
Noninterest expense
    371       436       46       50  
Net income
    94       83       37       29  
Average loans and leases
    18,661       18,822       8,286       7,972  
Average deposits
    43,229       43,495       3,498       3,444  
Net loan charge-offs
    18       19       2       2  
Return on average allocated equity
    21.38 %     18.52 %     19.37 %     15.80 %
Average full-time equivalent employees
    8,322       9,516       310       320  
 
                                 
Nine months ended September 30,   Regional Banking     Commercial Banking
dollars in millions   2007     2006     2007     2006  
 
Total revenue (TE)
  $ 1,781     $ 1,730     $ 279     $ 293  
Provision (credit) for loan losses
    51       60       (15 )     11  
Noninterest expense
    1,192       1,283       144       152  
Net income
    336       242       94       81  
Average loans and leases
    18,535       18,860       8,126       7,943  
Average deposits
    42,994       43,009       3,464       3,450  
Net loan charge-offs
    56       61       9       13  
Return on average allocated equity
    25.85 %     18.28 %     17.05 %     14.84 %
Average full-time equivalent employees
    8,726       9,378       317       319  
 
Supplementary Information (National Banking lines of business)
                                                                 
Three months ended September 30,   Real Estate Capital     Equipment Finance     Institutional and Capital Markets     Consumer Finance
dollars in millions   2007     2006     2007     2006     2007     2006     2007     2006  
 
Total revenue (TE)
  $ 104     $ 170     $ 139     $ 137     $ 183     $ 190     $ 85     $ 89  
Provision (credit) for loan losses
    43       7       16       11       (3 )     3       12       (8 )
Noninterest expense
    77       70       94       81       118       110       39       43  
Income (loss) from continuing operations
    (10 )     58       18       28       42       48       22       35  
Net income (loss)
    (10 )     58       18       28       42       48       8       42  
Average loans and leasesa
    13,187       12,854       10,681       10,100       7,693       7,390       8,716       7,527  
Average loans held for sale a
    1,584       1,022       6       6       373       454       2,729       3,071  
Average deposits a
    5,559       3,593       16       19       6,633       7,042       425       452  
Net loan charge-offs
    7             16       11       5       5       11       6  
Return on average allocated equity a
    (2.96 )%     19.06 %     7.92 %     13.02 %     14.34 %     16.46 %     11.81 %     20.85 %
Return on average allocated equity
    (2.96 )     19.06       7.92       13.02       14.34       16.46       4.29       18.29  
Average full-time equivalent employees
    1,007       970       985       927       1,320       1,385       529       1,023  
 
                                                                 
Nine months ended September 30,   Real Estate Capital     Equipment Finance     Institutional and Capital Markets     Consumer Finance
dollars in millions   2007     2006     2007     2006     2007     2006     2007     2006  
 
Total revenue (TE)
  $ 458     $ 502     $ 427     $ 397     $ 557     $ 589     $ 285     $ 260  
Provision (credit) for loan losses
    51       9       45       16       (1 )     (4 )     35       5  
Noninterest expense
    226       205       272       230       349       343       121       134  
Income from continuing operations
    113       180       69       95       130       157       81       77  
Net income
    113       180       69       95       130       157       56       99  
Average loans and leases a
    12,925       12,682       10,590       9,849       7,529       7,605       8,441       7,409  
Average loans held for sale a
    1,325       765       7       16       327       236       2,672       3,005  
Average deposits a
    4,910       3,422       15       16       6,683       6,729       401       430  
Net loan charge-offs (recoveries)
    11       4       45       18       5       (3 )     30       23  
Return on average allocated equity a
    11.65 %     20.21 %     10.39 %     15.30 %     14.70 %     18.63 %     14.90 %     15.41 %
Return on average allocated equity
    11.65       20.21       10.39       15.30       14.70       18.63       10.30       14.47  
Average full-time equivalent employees
    990       977       969       926       1,325       1,321       671       1,011  
 
(a)   From continuing operations.
 
TE = Taxable Equivalent

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5. Securities
Key classifies each security held into one of four categories: trading, available for sale, investment or other investments.
Trading account securities. These are debt and equity securities that Key purchases and holds with the intent of selling them in the near term. Trading account securities are reported at fair value ($1.1 billion at September 30, 2007, $912 million at December 31, 2006, and $817 million at September 30, 2006) and are included in “short-term investments” on the balance sheet. Realized and unrealized gains and losses on trading account securities are reported in “investment banking and capital markets income” on the income statement.
Securities available for sale. These are securities that Key intends to hold for an indefinite period of time and that may be sold in response to changes in interest rates, prepayment risk, liquidity needs or other factors. Securities available for sale, which include debt and marketable equity securities with readily determinable fair values, are reported at fair value. Unrealized gains and losses (net of income taxes) deemed temporary are recorded in shareholders’ equity as a component of “accumulated other comprehensive loss” on the balance sheet. Unrealized losses on specific securities deemed to be “other-than-temporary” are included in “net securities gains (losses)” on the income statement, as are actual gains and losses resulting from the sales of securities.
When Key retains an interest in loans it securitizes, it bears risk that the loans will be prepaid (which would reduce expected interest income) or not paid at all. Key accounts for these retained interests as debt securities and classifies them as available for sale.
“Other securities” held in the available-for-sale portfolio are primarily marketable equity securities.
Investment securities. These are debt securities that Key has the intent and ability to hold until maturity. Debt securities are carried at cost, 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. “Other securities” held in the investment securities portfolio are primarily foreign bonds.
Other investments. Principal investments ¾ investments in equity and mezzanine instruments made by Key’s Principal Investing unit ¾ represent 64% of other investments at September 30, 2007. These securities include direct investments (investments made in a particular company), as well as indirect investments (investments made through funds that include other investors). Principal investments are predominantly made in privately-held companies and are carried at fair value ($970 million at September 30, 2007, $830 million at December 31, 2006, and $843 million at September 30, 2006). Changes in estimated fair values, and actual gains and losses on sales of principal investments, are included in “other income” on the income statement.
In addition to principal investments, “other investments” include other equity and mezzanine instruments that do not have readily determinable fair values. These securities include certain real estate-related investments that are carried at estimated fair value, as well as other types of securities that generally are carried at cost. The carrying amount of the securities carried at cost is adjusted for declines in value that are considered to be other-than-temporary. These adjustments are included in “investment banking and capital markets income” on the income statement. Neither these securities nor principal investments have stated maturities.
The amortized cost, unrealized gains and losses, and approximate fair value of Key’s securities available for sale and investment securities are presented in the following tables. Gross unrealized gains and losses are represented by the difference between the amortized cost and the fair value of securities on the balance sheet as of the dates indicated. Accordingly, the amount of these gains and losses may change in the future as market conditions improve or worsen.

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    September 30, 2007
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
in millions   Cost     Gains     Losses     Value  
 
SECURITIES AVAILABLE FOR SALE
                               
U.S. Treasury, agencies and corporations
  $ 18                 $ 18  
States and political subdivisions
    12                   12  
Collateralized mortgage obligations
    6,357     $ 32     $ 37       6,352  
Other mortgage-backed securities
    1,188       4       7       1,185  
Retained interests in securitizations
    149       43             192  
Other securities
    141       17       2       156  
 
Total securities available for sale
  $ 7,865     $ 96     $ 46     $ 7,915  
 
                       
 
                               
 
INVESTMENT SECURITIES
                               
States and political subdivisions
  $ 15                 $ 15  
Other securities
    21                   21  
 
Total investment securities
  $ 36                 $ 36  
 
                       
 
                                 
    December 31, 2006
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
in millions   Cost     Gains     Losses     Value  
 
SECURITIES AVAILABLE FOR SALE
                               
U.S. Treasury, agencies and corporations
  $ 94                 $ 94  
States and political subdivisions
    14     $ 1             15  
Collateralized mortgage obligations
    7,098       13     $ 110       7,001  
Other mortgage-backed securities
    336       2       4       334  
Retained interests in securitizations
    151       57             208  
Other securities
    165       10             175  
 
Total securities available for sale
  $ 7,858     $ 83     $ 114     $ 7,827  
 
                       
 
                               
 
INVESTMENT SECURITIES
                               
States and political subdivisions
  $ 20     $ 1           $ 21  
Other securities
    21                   21  
 
Total investment securities
  $ 41     $ 1           $ 42  
 
                       
 
                                 
    September 30, 2006
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
in millions   Cost     Gains     Losses     Value  
 
SECURITIES AVAILABLE FOR SALE
                               
U.S. Treasury, agencies and corporations
  $ 220                 $ 220  
States and political subdivisions
    16     $ 1             17  
Collateralized mortgage obligations
    6,762       13     $ 125       6,650  
Other mortgage-backed securities
    210       2       3       209  
Retained interests in securitizations
    122       35             157  
Other securities
    179       9             188  
 
Total securities available for sale
  $ 7,509     $ 60     $ 128     $ 7,441  
 
                       
 
                               
 
INVESTMENT SECURITIES
                               
States and political subdivisions
  $ 26     $ 1           $ 27  
Other securities
    15                   15  
 
Total investment securities
  $ 41     $ 1           $ 42  
 
                       
 

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6. Loans and Loans Held for Sale
Key’s loans by category are summarized as follows:
                         
    September 30,     December 31,     September 30,  
in millions   2007     2006     2006  
 
Commercial, financial and agricultural
  $ 23,192     $ 21,412     $ 21,556  
Commercial real estate:
                       
Commercial mortgage
    9,272       8,426       8,266  
Construction
    8,214       8,209       8,272  
 
Total commercial real estate loans
    17,486       16,635       16,538  
Commercial lease financing
    10,309       10,259       9,860  
 
Total commercial loans
    50,987       48,306       47,954  
Real estate — residential mortgage
    1,583       1,442       1,407  
Home equity
    10,904       10,826       10,988  
Consumer — direct
    1,308       1,536       1,576  
Consumer — indirect:
                       
Marine
    3,549       3,077       2,982  
Other
    668       639       644  
 
Total consumer — indirect loans
    4,217       3,716       3,626  
 
Total consumer loans
    18,012       17,520       17,597  
 
Total loans
  $ 68,999     $ 65,826     $ 65,551  
 
                 
 
Key uses interest rate swaps to manage interest rate risk; these swaps modify the repricing (characteristics of certain loans. For more information about such swaps, see Note 19 (“Derivatives and Hedging Activities”), which begins on page 100 of Key’s 2006 Annual Report to Shareholders.
Key’s loans held for sale by category are summarized as follows:
                         
    September 30,     December 31,     September 30,  
in millions   2007     2006     2006  
 
Commercial, financial and agricultural
  $ 67     $ 47     $ 219  
Real estate — commercial mortgage
    1,560       946       1,062  
Real estate — construction
    237       36       198  
Commercial lease financing
    5       3       2  
Real estate — residential mortgage
    36       21       21  
Home equity a
    1       180       2,485  
Education
    2,877       2,390       3,147  
Automobile
    8       14       16  
 
Total loans held for sale
  $ 4,791     $ 3,637     $ 7,150  
 
                 
 
(a)   On August 1, 2006, Key transferred $2.5 billion of home equity loans from the loan portfolio to loans held for sale in connection with the anticipated November 29, 2006, sale of the Champion Mortgage finance business.

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Changes in the allowance for loan losses are summarized as follows:
                                 
    Three months ended     Nine months ended
    September 30,     September 30,
in millions   2007     2006     2007     2006  
 
Balance at beginning of period
  $ 945     $ 956     $ 944     $ 966  
Charge-offs
    (82 )     (70 )     (218 )     (194 )
Recoveries
    23       27       62       78  
 
Net loans charged off
    (59 )     (43 )     (156 )     (116 )
Provision for loan losses from continuing operations
    69       35       166       97  
Provision for loan losses from discontinued operations
          (4 )           (3 )
Foreign currency translation adjustment
                1        
 
Balance at end of period
  $ 955     $ 944     $ 955     $ 944  
 
                       
 
Changes in the liability for credit losses on lending-related commitments are summarized as follows:
                                 
    Three months ended     Nine months ended
    September 30,     September 30,
in millions   2007     2006     2007     2006  
 
Balance at beginning of period
  $ 50     $ 59     $ 53     $ 59  
Provision for losses on lending-related commitments
    5             3        
Charge-offs
                (1 )      
 
Balance at end of period a
  $ 55     $ 59     $ 55     $ 59  
 
                       
 
(a)   Included in “accrued expense and other liabilities” on the consolidated balance sheet.
7. Mortgage Servicing Assets
Key originates and periodically sells commercial mortgage loans which it continues to service for the buyers. Key may also purchase the right to service commercial mortgage loans for other lenders. Changes in the carrying amount of mortgage servicing assets are summarized as follows:
                 
    Nine months ended
    September 30,
in millions   2007     2006  
 
Balance at beginning of period
  $ 247     $ 248  
Servicing retained from loan sales
    16       10  
Purchases
    122       29  
Amortization
    (63 )     (48 )
 
Balance at end of period
  $ 322     $ 239  
 
           
 
Fair value at beginning of period
  $ 332     $ 301  
Fair value at end of period
    420       329  
 
The fair value of mortgage servicing assets is estimated by calculating the present value of future cash flows associated with servicing the loans. This calculation uses a number of assumptions that are based on current market conditions. Primary economic assumptions used to measure the fair value of Key’s mortgage servicing assets at September 30, 2007 and 2006, are as follows:
¨   prepayment speed generally at an annual rate of 0.00% to 25.00%;
 
¨   expected credit losses at a static rate of 2.00%; and
 
¨   residual cash flows discount rate of 8.50% to 15.00%.
Changes in these assumptions could cause the fair value of mortgage servicing assets to change in the future. The volume of loans serviced and expected credit losses are critical to the valuation of servicing assets. A 1.00% increase in the assumed default rate of commercial mortgage loans at September 30, 2007, would cause a $7 million decrease in the fair value of Key’s mortgage servicing assets.

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Contractual fee income from servicing commercial mortgage loans totaled $54 million for each of the nine-month periods ended September 30, 2007 and 2006. The amortization of servicing assets for the respective nine-month periods, as shown in the table above, is recorded as a reduction to fee income. Both the contractual fee income and the amortization are recorded in “other income” on the income statement.
Additional information pertaining to the accounting for mortgage and other servicing assets is included in Note 1 (“Basis of Presentation”) under the heading “Servicing Assets” on page 7.
8. Variable Interest Entities
A VIE is a partnership, limited liability company, trust or other legal entity that meets any one of certain criteria specified in Revised Interpretation No. 46. This interpretation requires a VIE to be consolidated by the party that is exposed to a majority of the VIE’s expected losses and/or residual returns (i.e., the primary beneficiary).
Key’s VIEs, including those consolidated and those in which Key holds a significant interest, are summarized below. Key defines a “significant interest” in a VIE as a subordinated interest that exposes Key to a significant portion, but not the majority, of the VIE’s expected losses or residual returns.
                         
    Consolidated VIEs     Unconsolidated VIEs
                    Maximum  
in millions   Total Assets     Total Assets     Exposure to Loss  
 
September 30, 2007
                       
Commercial paper conduit
    $            151       N/A       N/A  
Low-income housing tax credit (“LIHTC”) funds
    281     $ 186        
LIHTC investments
    N/A       781     $ 273  
 
N/A = Not Applicable
The noncontrolling interests associated with the consolidated LIHTC guaranteed funds are considered mandatorily redeemable instruments and are recorded in “accrued expense and other liabilities” on the balance sheet. The FASB has indefinitely deferred the measurement and recognition provisions of SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity,” for mandatorily redeemable noncontrolling interests associated with finite-lived subsidiaries, such as Key’s LIHTC guaranteed funds. Key currently accounts for these interests as minority interests and adjusts the financial statements each period for the investors’ share of the funds’ profits and losses. At September 30, 2007, the settlement value of these noncontrolling interests was estimated to be between $295 million and $347 million, while the recorded value, including reserves, totaled $283 million.
Key’s Principal Investing unit and the Real Estate Capital line of business make equity and mezzanine investments in entities, some of which are VIEs. These investments are held by nonregistered investment companies subject to the provisions of the American Institute of Certified Public Accountants (“AICPA”) Audit and Accounting Guide, “Audits of Investment Companies.” The FASB deferred the effective date of Revised Interpretation No. 46 for such nonregistered investment companies until the AICPA clarifies the scope of the Audit Guide. As a result, Key is not currently applying the accounting or disclosure provisions of Revised Interpretation No. 46 to its principal and real estate equity and mezzanine investments, which remain unconsolidated. As discussed in Note 1 (“Basis of Presentation”) under the heading “Accounting Pronouncements Pending Adoption” on page 9, in May 2007, the FASB issued Staff Position FIN 46(R)-7, which provides an exception to the scope of Revised Interpretation No. 46 for investment companies within the scope of SOP No. 07-1. Staff Position FIN 46(R)-7 will be effective for fiscal years beginning on or after December 15, 2007 (effective January 1, 2008, for Key). Management is evaluating the potential effect this guidance may have on Key’s financial condition or results of operations.
Additional information pertaining to Revised Interpretation No. 46 and the activities of the specific VIEs with which Key is involved is provided in Note 8 (“Loan Securitizations, Servicing and Variable Interest Entities”) of Key’s 2006 Annual Report to Shareholders under the heading “Variable Interest Entities” on page 84.

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9. Nonperforming Assets and Past Due Loans
Impaired loans totaled $344 million at September 30, 2007, compared to $95 million at December 31, 2006, and $122 million at September 30, 2006. Impaired loans averaged $240 million for the third quarter of 2007 and $121 million for the third quarter of 2006.
Key’s nonperforming assets and past due loans are as follows:
                         
    September 30,     December 31,     September 30,  
in millions   2007     2006     2006  
 
Impaired loans
  $ 344     $ 95     $ 122  
Other nonaccrual loans
    154       120       101  
 
Total nonperforming loans
    498       215       223  
 
                       
Nonperforming loans held for salea
    6       3       56  
 
                       
Other real estate owned (“OREO”)
    21       57       52  
Allowance for OREO losses
    (1 )     (3 )     (3 )
 
OREO, net of allowance
    20       54       49  
Other nonperforming assets
    46  b     1       1  
 
Total nonperforming assets
  $ 570     $ 273     $ 329  
 
                 
 
Impaired loans with a specifically allocated allowance
  $ 35     $ 34     $ 27  
Specifically allocated allowance for impaired loans
    11       14       12  
 
Accruing loans past due 90 days or more
  $ 190     $ 120     $ 125  
Accruing loans past due 30 through 89 days
    717       644       715  
 
(a)   On August 1, 2006, Key transferred approximately $55 million of home equity loans from nonperforming loans to nonperforming loans held for sale in connection with the anticipated November 29, 2006, sale of the Champion Mortgage finance business.
(b)   Primarily investments held by the Private Equity unit within Key’s Real Estate Capital line of business.
At September 30, 2007, Key did not have any significant commitments to lend additional funds to borrowers with loans on nonperforming status.
Management evaluates the collectibility of Key’s loans as described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan Losses” on page 69 of Key’s 2006 Annual Report to Shareholders.

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10. Capital Securities Issued by Unconsolidated Subsidiaries
KeyCorp owns the outstanding common securities of business trusts that issued corporation-obligated mandatorily redeemable preferred capital securities. The trusts used the proceeds from the issuance of their capital securities and common securities to buy debentures issued by KeyCorp. These debentures are the trusts’ only assets; the interest payments from the debentures finance the distributions paid on the capital securities.
The capital securities provide an attractive source of funds; they constitute Tier 1 capital for regulatory reporting purposes, but have the same tax advantages as debt for federal income tax purposes. During the first quarter of 2005, the Federal Reserve Board adopted a rule that allows bank holding companies to continue to treat capital securities as Tier 1 capital, but imposed stricter quantitative limits that take effect after a five-year transition period ending March 31, 2009. Management believes the new rule will not have any material effect on Key’s financial condition.
KeyCorp unconditionally guarantees the following payments or distributions on behalf of the trusts:
¨   required distributions on the capital securities;
 
¨   the redemption price when a capital security is redeemed; and
 
¨   amounts due if a trust is liquidated or terminated.
During the first nine months of 2007, the business trusts did not repurchase any capital securities and KeyCorp did not repurchase any of the related debentures.
The capital securities, common securities and related debentures are summarized as follows:
                                         
                    Principal     Interest Rate     Maturity  
    Capital             Amount of     of Capital     of Capital  
    Securities,     Common     Debentures,     Securities and     Securities and  
dollars in millions   Net of Discount a     Securities     Net of Discount b     Debentures c     Debentures  
 
September 30, 2007
                                       
KeyCorp Capital I
  $ 197     $ 8     $ 205       6.100 %     2028  
KeyCorp Capital II
    171       8       165       6.875       2029  
KeyCorp Capital III
    218       8       197       7.750       2029  
KeyCorp Capital V
    161       5       180       5.875       2033  
KeyCorp Capital VI
    72       2       77       6.125       2033  
KeyCorp Capital VII
    224       8       258       5.700       2035  
KeyCorp Capital VIII
    251             250       7.000       2066  
KeyCorp Capital IX
    488             500       6.750       2066  
 
Total
  $ 1,782     $ 39     $ 1,832       6.611 %      
 
                                 
 
December 31, 2006
  $ 1,804     $ 39     $ 1,832       6.613 %      
 
                                 
 
September 30, 2006
  $ 1,830     $ 54     $ 1,847       6.977 %      
 
                                 
 
(a)   The capital securities must be redeemed when the related debentures mature, or earlier if provided in the governing indenture. Each issue of capital securities carries an interest rate identical to that of the related debenture. Included in certain capital securities at September 30, 2007, December 31, 2006, and September 30, 2006, are basis adjustments of ($11) million, $11 million and $37 million, respectively, related to fair value hedges. See Note 19 (“Derivatives and Hedging Activities”), which begins on page 100 of Key’s 2006 Annual Report to Shareholders, for an explanation of fair value hedges.
 
(b)   KeyCorp has the right to redeem its debentures: (i) in whole or in part, on or after July 1, 2008 (for debentures owned by Capital I), March 18, 1999 (for debentures owned by Capital II), July 16, 1999 (for debentures owned by Capital III), July 21, 2008 (for debentures owned by Capital V), December 15, 2008 (for debentures owned by Capital VI), June 15, 2010 (for debentures owned by Capital VII), June 15, 2011 (for debentures owned by Capital VIII) and December 15, 2011 (for debentures owned by Capital IX); and, (ii) in whole at any time within 90 days after and during the continuation of a “tax event,” an “investment company event” or a “capital treatment event” (as defined in the applicable indenture). If the debentures purchased by Capital I, Capital V, Capital VI, Capital VII, Capital VIII or Capital IX are redeemed before they mature, the redemption price will be the principal amount, plus any accrued but unpaid interest. If the debentures purchased by Capital II or Capital III are redeemed before they mature, the redemption price will be the greater of: (a) the principal amount, plus any accrued but unpaid interest or (b) the sum of the present values of principal and interest payments discounted at the Treasury Rate (as defined in the applicable indenture), plus 20 basis points (25 basis points for Capital III), plus any accrued but unpaid interest. When debentures are redeemed in response to tax or capital treatment events, the redemption price generally is slightly more favorable to KeyCorp.
 
(c)   The interest rates for Capital II, Capital III, Capital V, Capital VI, Capital VII, Capital VIII and Capital IX are fixed. Capital I has a floating interest rate equal to three-month LIBOR plus 74 basis points; it reprices quarterly. The rates shown as the total at September 30, 2007, December 31, 2006, and September 30, 2006, are weighted-average rates.

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11. Employee Benefits
Pension Plans
Net pension cost for all funded and unfunded plans includes the following components:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
in millions   2007     2006     2007     2006  
 
Service cost of benefits earned
  $ 12     $ 12     $ 38     $ 36  
Interest cost on projected benefit obligation
    15       13       44       41  
Expected return on plan assets
    (22 )     (22 )     (66 )     (66 )
Amortization of losses
    7       8       21       23  
 
Net pension cost
    12       11       37       34  
Curtailment gain
                (3 )      
 
Total pension cost
  $ 12     $ 11     $ 34     $ 34  
 
                       
 
Other Postretirement Benefit Plans
Key sponsors a contributory postretirement healthcare plan that covers substantially all active and retired employees hired before 2001 who meet certain eligibility criteria. Retirees’ contributions are adjusted annually to reflect certain cost-sharing provisions and benefit limitations. Key also sponsors life insurance plans covering certain grandfathered employees. These plans are principally noncontributory. Separate Voluntary Employee Beneficiary Association trusts are used to fund the healthcare plan and one of the life insurance plans.
Net postretirement benefit cost for all funded and unfunded plans includes the following components:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
in millions   2007     2006     2007     2006  
 
Service cost of benefits earned
  $ 2     $ 1     $ 6     $ 4  
Interest cost on accumulated postretirement benefit obligation
    2       2       5       6  
Expected return on plan assets
    (1 )     (1 )     (3 )     (3 )
Amortization of unrecognized transition obligation
    1       1       3       3  
Amortization of losses
          1             2  
 
Net postretirement benefit cost
  $ 4     $ 4     $ 11     $ 12  
 
                       
 
12. Income Taxes
Lease Financing Transactions
In the ordinary course of business, Key’s equipment finance business unit (“KEF”) enters into various types of lease financing transactions. Between 1996 and 2004, KEF entered into three types of lease financing transactions with both foreign and domestic customers (primarily municipal authorities) for terms ranging from ten to fifty years. Lease in, Lease out (“LILO”) transactions are leveraged leasing transactions in which KEF leases property from an unrelated third party and then leases the property back to that party. The transaction is similar to a sale-leaseback, except that the property is leased by KEF rather than purchased. Qualified Technological Equipment Leases (“QTEs”) and Service Contract Leases are even more like sale-leaseback transactions, as KEF is considered to be the purchaser of the equipment for tax purposes. LILO and Service Contract Lease transactions involve commuter rail equipment, public utility facilities and commercial aircraft. QTE transactions involve sophisticated high technology hardware and related software, such as telecommunications equipment. Like other forms of leasing transactions, LILO transactions generate income tax deductions for Key from net rental expense associated with the leased property, interest expense on nonrecourse debt incurred to fund the transaction, and transaction costs. QTE and Service Contract Lease transactions generate rental income, as well as deductions from the depreciation of the property, interest expense on nonrecourse debt incurred to fund the transaction, and transaction costs.

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Prior to 2004, LILO, QTE and Service Contract Leases were prevalent in the financial services industry and in certain other industries. The tax treatment that Key applied was based on applicable statutes, regulations and judicial authority. Subsequently, the Internal Revenue Service (“IRS”) has challenged the tax treatment of these transactions by a number of bank holding companies and other corporations.
The IRS has completed audits of Key’s income tax returns for the 1995 through 2003 tax years and has disallowed all net deductions taken in those tax years that relate to LILOs, QTEs and Service Contract Leases. Key appealed the examination results for the tax years 1995 through 1997, which pertained to LILOs only, to the Appeals Division of the IRS. During the fourth quarter of 2005, discussions with the Appeals Division were discontinued without a resolution. In April 2006, Key received a final assessment from the IRS, consisting of taxes, interest and penalties, disallowing all LILO deductions taken in those tax years. Key paid the assessment and filed a refund claim for the total amount. Key has also filed appeals with the Appeals Division of the IRS with regard to the proposed disallowance of the LILO, QTE and Service Contract Lease deductions taken in the 1998 through 2003 tax years.
Management continues to believe that Key’s treatment of these LILO, QTE and Service Contract Lease transactions is appropriate and in compliance with applicable tax law and regulations. Key intends to vigorously pursue the IRS appeals process and litigation alternatives. In addition, in connection with one Service Contract Lease transaction entered into by AWG Leasing Trust (“AWG Leasing”), in which Key is a partner, the IRS completed its audit for the 1998 through 2003 tax years, disallowed all deductions related to the transaction for those years and assessed penalties. In March 2007, Key filed a lawsuit in the United States District Court for the Northern District of Ohio (captioned AWG Leasing Trust, KSP Investments, Inc., as Tax Matters Partner v. United States of America, and referred to herein as the “AWG Leasing Litigation”) claiming that the disallowance of the deductions and assessment of penalties were erroneous. A trial date has been set for January 21, 2008.
Management believes Key’s tax position is correct and well-supported by applicable statutes, regulations and judicial authority, but tax litigation is inherently uncertain. Consequently, management cannot predict the outcome of the AWG Leasing Litigation or its other disputes with the IRS related to its LILO, QTE or Service Contract Lease transactions. If Key were not to prevail in these efforts, in addition to accrued deferred taxes of approximately $1.7 billion reflected on Key’s balance sheet as of September 30, 2007, Key would owe interest on any taxes and possibly penalties. In the event of an unfavorable resolution of this issue, management estimates that, as of September 30, 2007, the after-tax interest cost on any taxes due could be up to approximately $385 million. This amount would vary based upon the then applicable interest rates, and grow over the period any tax assessments remain outstanding. No reserves have been established for any such interest or penalties. An adverse outcome in these disputes could have a material adverse effect on Key’s results of operations and a potentially substantial impact on its capital as discussed in the following section.
Tax-Related Accounting Pronouncements Adopted in 2007
Accounting for leveraged leases. In July 2006, the FASB issued Staff Position No. 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction,” which provides additional guidance on the application of SFAS No. 13, “Accounting for Leases.” This guidance affects when earnings from leveraged lease transactions (such as LILOs, QTEs and Service Contract Leases) will be recognized, and requires a lessor to recalculate its recognition of lease income when there are changes or projected changes in the timing of cash flows, including changes due to final or expected settlements of tax matters. Previously, leveraged lease transactions were required to be recalculated only when a change in the total projected net income from the lease occurred. Key adopted this guidance on January 1, 2007, and recorded a cumulative after-tax charge of $52 million to retained earnings related to the LILO transactions. Future earnings are expected to increase over the remaining term of the affected leases by a similar amount.

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An adverse outcome in the AWG Leasing Litigation, certain settlement scenarios or other factors could change management’s current assumptions pertaining to the expected timing of the cash flows related to income taxes for some or all of the leveraged lease transactions previously described. In the event of such a change in management’s assumptions, in accordance with Staff Position No. 13-2, Key would be required to recalculate its lease income from the inception of the affected leases and recognize a reduction in its net investment with a corresponding charge to earnings in the period in which the recalculation occurs. Management is currently unable to make a determination regarding the ultimate financial impact, if any, of these events because of the uncertainty of the outcome of the AWG Leasing Litigation, the range of possible settlement opportunities that might be available to Key and other factors. Management believes that under certain outcomes, the recalculation would result in a charge that could have a material adverse effect on Key’s results of operations and a potentially substantial impact on its capital. However, management would expect future earnings to increase over the remaining term of the affected leases by an amount equal to a substantial portion of the charge.
Accounting for uncertain tax positions. In July 2006, the FASB also issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” which clarifies the application of SFAS No. 109, “Accounting for Income Taxes,” by defining the minimum threshold that a tax position must meet for the associated tax benefit to be recognized in a company’s financial statements. In accordance with this guidance, a company may recognize a benefit if management concludes that the tax position, based solely on its technical merits, is “more likely than not” to be sustained upon examination. If such a conclusion is reached, the tax benefit is measured as the largest amount of such benefit that is greater than 50% likely to be realized upon ultimate settlement. This interpretation also provides guidance on measurement and derecognition of tax benefits, and requires expanded disclosures.
Key adopted FASB Interpretation No. 48 on January 1, 2007, which resulted in an immaterial increase in Key’s liability for unrecognized tax benefits and was accounted for as a reduction to retained earnings. The total amount of unrecognized tax benefits was $27 million at January 1, 2007, and $21 million at September 30, 2007. The decrease in unrecognized tax benefits was a result of $6 million of tax payments made in connection with tax positions taken in prior years. The amount of unrecognized tax benefits, if recognized, would impact Key’s effective tax rate. Additionally, the amount of unrecognized tax benefits could materially increase or decrease over the next twelve months as a result of developments in the AWG Leasing Litigation or any possible settlement of tax matters related to the leveraged lease transactions. However, management cannot currently estimate the range of possible change.
As permitted under FASB Interpretation No. 48, Key continues to recognize interest and penalties related to unrecognized tax benefits in income tax expense. During the nine-month period ended September 30, 2007, Key recognized $4 million of interest. At September 30, 2007, Key had a $19 million liability for accrued interest payable on the balance sheet.
Key files income tax returns in the United States federal jurisdiction, as well as various state and foreign jurisdictions. With the exception of the California and New York jurisdictions, Key is not subject to U.S. federal, state and local, and foreign income tax examinations by tax authorities for years prior to 2001. Income tax returns filed in California and New York are subject to examination beginning with the years 1995 and 2000, respectively. As previously discussed, the audits of the 1998 through 2003 federal income tax returns are currently on appeal to the Appeals Division of the IRS. The outcomes of these appeals could impact the recognition of benefits related to Key’s tax positions.

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13. Contingent Liabilities and Guarantees
Legal Proceedings
Residual value insurance litigation. Key has previously reported on its on-going litigation with Swiss Reinsurance America Corporation (“Swiss Re”) in the United States Federal District Court in Ohio relating to insurance coverage of the residual value of certain automobile leases through Key Bank USA (the “Residual Value Litigation”).
As previously reported, on February 13, 2007, Key and Swiss Re entered into an agreement to settle the Residual Value Litigation, subject to certain conditions. On February 16, 2007, the conditions to settlement were satisfied. Under the settlement agreement, Swiss Re agreed to pay Key $279 million in two installments: $50 million, which was paid on March 15, 2007, and $229 million, which was paid on June 29, 2007. As a result of the settlement, during the first quarter of 2007, Key recorded a one-time gain of $26 million ($17 million after tax, or $.04 per diluted common share), representing the difference between the proceeds received and the receivable recorded on Key’s balance sheet.
Tax disputes. In the ordinary course of business, Key enters into certain transactions that have tax consequences. On occasion, the IRS may challenge a particular tax position taken by Key. The IRS has completed audits of Key’s income tax returns for the 1995 through 2003 tax years and has disallowed all deductions taken in those tax years that relate to certain lease financing transactions. Further information on these matters and on the potential implications to Key is included in Note 12 (“Income Taxes”) under the heading “Lease Financing Transactions” on page 25.
Honsador litigation. On May 23, 2007, in the case of Honsador Holdings LLC v. Key Principal Partners, LLC (“KPP”), pending in the Circuit Court of the First Circuit, a Hawaii state court, the jury returned a verdict in favor of the plaintiffs in a lawsuit relating to KPP’s investment in a Hawaiian business, and on June 13, 2007, the state court entered a final judgment in favor of the plaintiffs in the amount of $38.25 million (“Final Judgment”). During the three months ended June 30, 2007, Key established a $42 million reserve for this case for the verdict, legal costs and other expenses associated with the lawsuit.
On September 27, 2007, KPP filed a notice of appeal with the Intermediate Court of Appeals for the State of Hawaii, contesting the Final Judgment. On October 4, 2007, the trial court issued an amended final judgment in which the court modified the Final Judgment (the “Amended Final Judgment”). On October 22, 2007, KPP filed an amended notice of appeal, challenging both the Final Judgment and the Amended Final Judgment.
Other litigation. In the ordinary course of business, Key is subject to other legal actions that involve claims for substantial monetary relief. Based on information presently known to management, management believes there are no such legal actions to which KeyCorp or any of its subsidiaries is a party, or involving any of their properties, that, individually or in the aggregate, could reasonably be expected to have a material adverse effect on Key’s financial condition.
Guarantees
Key is a guarantor in various agreements with third parties. The following table shows the types of guarantees that Key had outstanding at September 30, 2007. Information pertaining to the basis for determining the liabilities recorded in connection with these guarantees is included in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Guarantees” on page 71 of Key’s 2006 Annual Report to Shareholders.

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    Maximum Potential        
    Undiscounted     Liability  
in millions   Future Payments     Recorded  
 
Financial guarantees:
               
Standby letters of credit
  $ 12,974     $ 35  
Credit enhancement for asset-backed commercial paper conduit
    28        
Recourse agreement with FNMA
    579       6  
Return guarantee agreement with LIHTC investors
    347       41  
Default guarantees
    12       1  
Written interest rate caps a
    105       7  
 
Total
  $ 14,045     $ 90  
 
           
 
(a)   At September 30, 2007, the weighted-average interest rate on written interest rate caps was 5.3%, and the weighted-average strike rate was 5.7%. Maximum potential undiscounted future payments were calculated assuming a 10% interest rate.
Standby letters of credit. These instruments, issued on behalf of clients, obligate Key to pay a specified third party when a client fails to repay an outstanding loan or debt instrument, or fails to perform some contractual nonfinancial obligation. Many of Key’s lines of business issue standby letters of credit to address clients’ financing needs. Any amounts drawn under standby letters of credit are treated as loans; they bear interest (generally at variable rates) and pose the same credit risk to Key as a loan. At September 30, 2007, Key’s standby letters of credit had a remaining weighted-average life of approximately 2.6 years, with remaining actual lives ranging from less than one year to as many as eleven years.
Credit enhancement for asset-backed commercial paper conduit. Key provides credit enhancement in the form of a committed facility to ensure the continuing operations of an asset-backed commercial paper conduit that is owned by a third party and administered by an unaffiliated financial institution. The commitment to provide credit enhancement extends until November 30, 2007, and specifies that in the event of default by certain borrowers whose loans are held by the conduit, Key will provide financial relief to the conduit in an amount that is based on defined criteria that consider the level of credit risk involved and other factors.
At September 30, 2007, Key’s maximum potential funding requirement under the credit enhancement facility totaled $28 million, but there were no drawdowns under the facility during the quarter. Key has no recourse or other collateral available to offset any amounts that may be funded under this credit enhancement facility. Management periodically evaluates Key’s commitment to provide credit enhancement to the conduit.
Recourse agreement with Federal National Mortgage Association. KeyBank participates as a lender in the Federal National Mortgage Association (“FNMA”) Delegated Underwriting and Servicing (“DUS”) program. As a condition to FNMA’s delegation of responsibility for originating, underwriting and servicing mortgages, KeyBank has agreed to assume a limited portion of the risk of loss during the remaining term on each commercial mortgage loan KeyBank sells to FNMA. Accordingly, KeyBank maintains a reserve for such potential losses in an amount estimated by management to approximate the fair value of KeyBank’s liability. At September 30, 2007, the outstanding commercial mortgage loans in this program had a remaining weighted-average term of 7.8 years, and the unpaid principal balance outstanding of loans sold by KeyBank as a participant in this program was approximately $1.8 billion. The maximum potential amount of undiscounted future payments that may be required under this program is generally equal to approximately one-third of the principal balance of loans outstanding at September 30, 2007. If payment is required under this program, Key would have an interest in the collateral underlying the commercial mortgage loan on which the loss occurred.
Return guarantee agreement with LIHTC investors. Key Affordable Housing Corporation (“KAHC”), a subsidiary of KeyBank, offered limited partnership interests to qualified investors. Partnerships formed by KAHC invested in low-income residential rental properties that qualify for federal LIHTCs under Section 42 of the Internal Revenue Code. In certain partnerships, investors pay a fee to KAHC for a guaranteed return that is based on the financial performance of the property and the property’s confirmed LIHTC status

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throughout a fifteen-year compliance period. If KAHC defaults on its obligation to provide the guaranteed return, Key is obligated to make any necessary payments to investors. In October 2003, management elected to discontinue new partnerships under this program.
No recourse or collateral is available to offset Key’s guarantee obligation other than the underlying income stream from the properties. These guarantees have expiration dates that extend through 2018. Key meets its obligations pertaining to the guaranteed returns generally by distributing tax credits and deductions associated with the specific properties.
As shown in the table on page 29, KAHC maintained a reserve in the amount of $41 million at September 30, 2007, which management believes will be sufficient to cover estimated future obligations under the guarantees. The maximum exposure to loss reflected in the table represents undiscounted future payments due to investors for the return on and of their investments. In accordance with FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” the amount of all fees received in consideration for any return guarantee agreements entered into or modified with LIHTC investors on or after January 1, 2003, has been recognized as a component of the recorded liability.
Default guarantees. Some lines of business provide or participate in various types of guarantees that obligate Key to perform if the debtor fails to satisfy all of its payment obligations to third parties. Key generally undertakes these guarantees to support or protect its underlying investment or where the risk profile of the debtor should provide an investment return. The terms of these default guarantees range from less than one year to as many as fifteen years. Although no collateral is held, Key would have recourse against the debtor for any payments made under a default guarantee.
Written interest rate caps. In the ordinary course of business, Key “writes” interest rate caps for commercial loan clients that have variable rate loans with Key and wish to limit their exposure to interest rate increases. At September 30, 2007, these caps had a weighted-average life of approximately 2.1 years.
Key is obligated to pay the client if the applicable benchmark interest rate exceeds a specified level (known as the “strike rate”). These instruments are accounted for as derivatives. Key’s potential amount of future payments under these obligations is mitigated by offsetting positions with third parties.
Other Off-Balance Sheet Risk
Other off-balance sheet risk stems from financial instruments that do not meet the definition of a guarantee as specified in FASB Interpretation No. 45 and from other relationships.
Significant liquidity facilities that support asset-backed commercial paper conduits. Key provides liquidity facilities to various asset-backed commercial paper conduits. These facilities obligate Key to provide funding in the event of a disruption in credit markets or other factors that preclude the issuance of commercial paper by the conduits. Key’s commitments to provide liquidity are periodically evaluated by management. Three of these liquidity facilities, all of which expire by September 29, 2008, obligate Key to provide funding of up to $166 million in total to a commercial paper conduit that is consolidated in accordance with Key’s consolidation policy described in Note 1 (“Basis of Presentation”), which begins on page 7. The aggregate amount available to be drawn by the conduit, which is based on the amount of current commitments to borrowers, was $128 million at September 30, 2007, but there were no drawdowns under these committed facilities at that date. Additional information pertaining to this conduit is included in this note under the heading “Guarantees” on page 28 and in Note 8 (“Loan Securitizations, Servicing and Variable Interest Entities”) of Key’s 2006 Annual Report to Shareholders under the heading “Consolidated VIEs” on page 84.
Key also provides liquidity facilities to several unconsolidated third-party commercial paper conduits. These liquidity facilities, all of which expire by November 10, 2010, obligate Key to provide funding of up to $687 million in total, with individual facilities ranging from $10 million to $100 million. The amounts available to be drawn, which are based on the amount of current commitments to borrowers, totaled $494 million at September 30, 2007, but there were no drawdowns under these committed facilities at that date.

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Indemnifications provided in the ordinary course of business. Key provides certain indemnifications primarily through representations and warranties in contracts that are entered into in the ordinary course of business in connection with loan sales and other ongoing activities, as well as in connection with purchases and sales of businesses. Amounts paid, if any, with respect to these indemnifications did not have a significant effect on Key’s financial condition or results of operations.
Intercompany guarantees. KeyCorp and certain other Key affiliates are parties to various guarantees that facilitate the ongoing business activities of other Key affiliates. These business activities encompass debt issuance, certain lease and insurance obligations, investments and securities, and certain leasing transactions involving clients.
14. Derivatives and Hedging Activities
Key, mainly through its subsidiary bank, KeyBank, is party to various derivative instruments that are used for asset and liability management, credit risk management and trading purposes. The primary derivatives that Key uses are interest rate swaps, caps and futures, and foreign exchange forward contracts. Generally, these instruments help Key manage exposure to market risk, mitigate the credit risk inherent in the loan portfolio and meet client financing needs. Market risk represents the possibility that economic value or net interest income will be adversely affected by changes in interest rates or other economic factors.
At September 30, 2007, Key had $464 million of derivative assets and $112 million of derivative liabilities on its balance sheet that arose from derivatives that were being used for hedging purposes. As of the same date, derivative assets and liabilities classified as trading derivatives totaled $1.0 billion and $951 million, respectively. Derivative assets and liabilities are recorded at fair value on the balance sheet.
Counterparty Credit Risk
The following table summarizes the fair value of Key’s derivative assets by type. These assets represent Key’s exposure to potential loss, as described below, before taking into account the effects of master netting arrangements and other means used to mitigate risk.
                         
    September 30,     December 31,     September 30,  
in millions   2007     2006     2006  
 
Interest rate
  $ 713     $ 697     $ 635  
Credit
    44       43       45  
Foreign exchange
    643       321       172  
Equity
    36       45       46  
Energy
    61       29       17  
 
Total
  $ 1,497     $ 1,135     $ 915  
 
                 
 
Like other financial instruments, derivatives contain an element of “credit risk”— the possibility that Key will incur a loss because a counterparty, which may be a bank or a broker/dealer, fails to meet its contractual obligations. This risk is measured as the expected positive replacement value of contracts. To mitigate credit risk when managing asset, liability and trading positions, Key deals exclusively with counterparties that have high credit ratings.
Key uses two additional means to manage exposure to credit risk on derivative contracts. First, Key generally enters into bilateral collateral and master netting arrangements. These agreements provide for the net settlement of all contracts with a single counterparty in the event of default. Second, Key’s Credit Administration department monitors credit risk exposure to the counterparty on each contract to determine appropriate limits on Key’s total credit exposure and decide whether to demand collateral. If Key determines that collateral is required, it is generally collected immediately. Key generally holds collateral in the form of cash and highly rated Treasury and agency-issued securities.

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At September 30, 2007, Key was party to derivative contracts with 53 different counterparties. These derivatives include interest rate swaps and caps, credit derivatives, foreign exchange contracts, equity derivatives and energy derivatives. Among these were contracts entered into to offset the risk of client exposure. Key had aggregate exposure of $448 million on these instruments to 26 of the 53 counterparties. However, at September 30, 2007, Key held approximately $309 million in pooled collateral to mitigate that exposure, resulting in net exposure of $139 million. The largest exposure to an individual counterparty was approximately $229 million, which Key secured with approximately $211 million in collateral.
Asset and Liability Management
Key uses fair value and cash flow hedging strategies to manage its exposure to interest rate risk. These strategies reduce the potential adverse impact of interest rate movements on future net interest income. For more information about these asset and liability management strategies, see Note 19 (“Derivatives and Hedging Activities”), which begins on page 100 of Key’s 2006 Annual Report to Shareholders.
The change in “accumulated other comprehensive loss” resulting from cash flow hedges is as follows:
                                 
                    Reclassification        
    December 31,     2007     of Gains to     September 30,  
in millions   2006     Hedging Activity     Net Income     2007  
 
Accumulated other comprehensive (loss) income resulting from cash flow hedges
  $ (19 )   $ 48     $ (6 )   $ 23  
 
Key reclassifies gains and losses from “accumulated other comprehensive loss” to earnings when a hedged item causes Key to pay variable-rate interest on debt, receive variable-rate interest on commercial loans, or sell or securitize commercial real estate loans. Key expects to reclassify an estimated $8 million of net losses on derivative instruments from “accumulated other comprehensive loss” to earnings during the next twelve months.
Credit Risk Management
Key uses credit derivatives ¾ primarily credit default swaps ¾ to mitigate credit risk by transferring a portion of the risk associated with the underlying extension of credit to a third party. These instruments are also used to manage portfolio concentration and correlation risks. At September 30, 2007, the notional amount of credit default swaps purchased by Key was $1.1 billion. Key also provides credit protection to other lenders through the sale of credit default swaps. These transactions may generate fee income and can diversify overall exposure to credit loss. At September 30, 2007, the notional amount of credit default swaps sold by Key was $50 million.
These derivatives are recorded on the balance sheet at fair value, which is based on the creditworthiness of the borrowers. Related gains or losses, as well as the premium paid or received for credit protection, are included in “investment banking and capital markets income” on the income statement. Key does not apply hedge accounting to credit derivatives.

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Trading Portfolio
Key’s trading portfolio includes:
¨   interest rate swap contracts entered into to accommodate the needs of clients;
 
¨   positions with third parties that are intended to offset or mitigate the interest rate risk of client positions;
 
¨   foreign exchange forward contracts entered into to accommodate the needs of clients; and
 
¨   proprietary trading positions in financial assets and liabilities.
The fair values of these trading portfolio items are included in “derivative assets” or “derivative liabilities” on the balance sheet. Adjustments to the fair values are included in “investment banking and capital markets income” on the income statement. Key has established a reserve in the amount of $12 million at September 30, 2007, which management believes will be sufficient to cover estimated future losses on the trading portfolio in the event of client default. Additional information pertaining to Key’s trading portfolio is summarized in Note 19 of Key’s 2006 Annual Report to Shareholders.

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Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
KeyCorp
We have reviewed the condensed consolidated balance sheets of KeyCorp and subsidiaries (“Key”) as of September 30, 2007 and 2006, and the related condensed consolidated statements of income for the three-month and nine-month periods then ended, and the condensed consolidated statements of changes in shareholders’ equity and cash flows for the nine-month periods ended September 30, 2007 and 2006. These financial statements are the responsibility of Key’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated interim financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Key as of December 31, 2006, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for the year then ended not presented herein, and in our report dated February 23, 2007, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2006, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Cleveland, Ohio
November 7, 2007

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Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations
Introduction
This section generally reviews the financial condition and results of operations of KeyCorp and its subsidiaries for the quarterly and year-to-date periods ended September 30, 2007 and 2006. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends in greater depth. When reading this discussion, also refer to the consolidated financial statements and related notes that appear on pages 3 through 33. A description of Key’s business is included under the heading “Description of Business” on page 18 of Key’s 2006 Annual Report to Shareholders. This description does not reflect the reorganization within some of Key’s lines of business that took effect January 1, 2007. For a current description of Key’s lines of business, see Note 4 (“Line of Business Results”), which begins on page 13.
Terminology
This report contains some shortened names and industry-specific terms. We want to explain some of these terms at the outset to provide a better understanding of the discussion that follows.
¨   KeyCorp refers solely to the parent holding company.
 
¨   KeyBank refers to KeyCorp’s subsidiary bank, KeyBank National Association.
 
¨   Key refers to the consolidated entity consisting of KeyCorp and its subsidiaries.
 
¨   In November 2006, Key sold the nonprime mortgage loan portfolio held by the Champion Mortgage finance business and announced a separate agreement to sell Champion’s loan origination platform. As a result of these actions, Key has accounted for this business as a discontinued operation. We use the phrase continuing operations in this document to mean all of Key’s business other than Champion. Key completed the sale of Champion’s origination platform in February 2007.
 
¨   Key engages in capital markets activities. These activities encompass a variety of products and services. Among other things, Key trades securities as a dealer, enters into derivative contracts (both to accommodate clients’ financing needs and for proprietary trading purposes), and conducts transactions in foreign currencies (both to accommodate clients’ needs and to benefit from fluctuations in exchange rates).
 
¨   All earnings per share data included in this discussion are presented on a diluted basis, which takes into account all common shares outstanding as well as potential common shares that could result from the exercise of outstanding stock options and other stock awards. Some of the financial information tables also include basic earnings per share, which takes into account only common shares outstanding.
 
¨   For regulatory purposes, capital is divided into two classes. Federal regulations prescribe that at least one-half of a bank or bank holding company’s total risk-based capital must qualify as Tier 1. Both total and Tier 1 capital serve as bases for several measures of capital adequacy, which is an important indicator of financial stability and condition. A more detailed explanation of total and Tier 1 capital and how they are calculated is presented in the section entitled “Capital,” which begins on page 61.
Long-term goals
Key’s long-term financial goals are to achieve an annual return on average equity at or above the median of its peer group and to grow earnings per common share at an annual rate of 8% to 10%. The strategy for achieving these goals is described under the heading “Corporate Strategy” on page 20 of Key’s 2006 Annual Report to Shareholders.

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Key from time-to-time uses capital that exceeds internal guidelines and minimum regulatory requirements to repurchase common shares in the open market or through privately-negotiated transactions. As a result of such repurchases, Key’s weighted-average fully-diluted common shares decreased to 397.8 million shares for the first nine months of 2007 from 411.0 million shares for the first nine months of 2006. Reducing the share count can foster both earnings per share growth and improved returns on average equity, but Key’s share repurchase activity was not significant enough to cause a material effect on either of these profitability measures in either the current or prior year periods.
Forward-looking statements
This report may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about our long-term goals, financial condition, results of operations, earnings, levels of net loan charge-offs and nonperforming assets, interest rate exposure and profitability. These statements usually can be identified by the use of forward-looking language such as “our goal,” “our objective,” “our plan,” “will likely result,” “expects,” “plans,” “anticipates,” “intends,” “projects,” “believes,” “estimates,” or other similar words, expressions or conditional verbs such as “will,” “would,” “could,” and “should.”
Forward-looking statements express management’s current expectations, forecasts of future events or long-term goals and, by their nature, are subject to assumptions, risks and uncertainties. Although management believes that the expectations, forecasts and goals reflected in these forward-looking statements are reasonable, actual results could differ materially for a variety of reasons, including the following factors:
¨   Interest rates could change more quickly or more significantly than management expects, which may have an adverse effect on Key’s financial results.
 
¨   Trade, monetary and fiscal policies of various governmental bodies may affect the economic environment in which Key operates, as well as its financial condition and results of operations.
 
¨   Recent problems in the mortgage markets and related conditions in the financial markets, or other issues could cause a deterioration in general economic conditions, or in the condition of the local economies or industries in which Key has significant operations or assets, and, among other things, materially impact credit quality in existing portfolios and/or Key’s ability to generate loans in the future.
 
¨   Increased competitive pressure among financial services companies may adversely affect Key’s ability to market its products and services.
 
¨   It could take Key longer than anticipated to implement strategic initiatives, including those designed to grow revenue or manage expenses; Key may be unable to implement certain initiatives; or the initiatives may be unsuccessful.
 
¨   Acquisitions and dispositions of assets, business units or affiliates could adversely affect Key in ways that management has not anticipated.
 
¨   Key may experience operational or risk management failures due to technological or other factors.
 
¨   Key may continue to become subject to heightened regulatory practices, requirements or expectations.
 
¨   Key may become subject to new legal obligations or liabilities, or the unfavorable resolution of pending litigation may have an adverse effect on its financial results or its capital.
 
¨   Changes in the stock markets, public debt markets and other capital markets, including continued disruption in the fixed income markets, could adversely affect Key’s ability to raise capital or other funding for liquidity and business purposes, as well as its revenues from client-based underwriting, investment banking and other capital markets-driven businesses.

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¨   Terrorist activities or military actions could disrupt the economy and the general business climate, which may have an adverse effect on Key’s financial results or condition and that of its borrowers.
 
¨   Key may become subject to new accounting, tax or regulatory practices or requirements, which impede its profitability.
Critical accounting policies and estimates
Key’s business is dynamic and complex. Consequently, management must exercise judgment in choosing and applying accounting policies and methodologies in many areas. These choices are important; not only are they necessary to comply with U.S. generally accepted accounting principles (“GAAP”), they also reflect management’s view of the most appropriate manner in which to record and report Key’s overall financial performance. All accounting policies are important, and all policies described in Note 1 (“Summary of Significant Accounting Policies”), which begins on page 67 of Key’s 2006 Annual Report to Shareholders, should be reviewed for a greater understanding of how Key’s financial performance is recorded and reported.
In management’s opinion, some accounting policies are more likely than others to have a significant effect on Key’s financial results and to expose those results to potentially greater volatility. These policies apply to areas of relatively greater business importance, or require management to exercise judgment, and to make assumptions and estimates that affect amounts reported in the financial statements. Because these assumptions and estimates are based on current circumstances, they may change over time or prove to be inaccurate.
Key relies heavily on the use of judgment, assumptions and estimates in a number of important areas, including accounting for the allowance for loan losses; loan securitizations; contingent liabilities, guarantees and income taxes; derivatives and related hedging activities; principal investments; goodwill; and pension and other postretirement obligations. A brief discussion of each of these areas appears on pages 20 through 22 of Key’s 2006 Annual Report to Shareholders.
During the first nine months of 2007, there were no significant changes in the manner in which Key’s critical accounting policies were applied or in which related assumptions and estimates were developed. Additionally, no new critical accounting policies were adopted.
Highlights of Key’s Performance
Financial performance
Key’s third quarter income from continuing operations was $224 million, or $.57 per diluted common share, compared to $305 million, or $.74 per share, for the third quarter of 2006. Key’s income from continuing operations for the first nine months of 2007 was $919 million, or $2.31 per diluted common share. This compares to income from continuing operations – before the cumulative effect of an accounting change – of $882 million, or $2.15 per share, for the first nine months of 2006.
Net income totaled $210 million, or $.54 per diluted common share, for the third quarter of 2007, compared to net income of $312 million, or $.76 per share, for the third quarter of 2006. Key’s net income for the first nine months of 2007 was $894 million, or $2.25 per diluted common share, compared to $909 million, or $2.21 per share, for the same period last year.
Figure 1 shows Key’s continuing and discontinued operating results and related performance ratios for the three- and nine-month periods ended September 30, 2007 and 2006. Key’s financial performance for each of the past five quarters and the nine-month periods ended September 30, 2007 and 2006, is summarized in Figure 3 on page 41.

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Figure 1. Results of Operations
                                 
    Three months ended     Nine months ended  
in millions, except per share amounts   9-30-07     9-30-06     9-30-07     9-30-06  
 
SUMMARY OF OPERATIONS
                               
Income from continuing operations before cumulative effect of accounting change
  $ 224     $ 305     $ 919     $ 882  
(Loss) income from discontinued operations, net of taxes a
    (14 )     7       (25 )     22  
Cumulative effect of accounting change, net of taxes
                      5  
 
Net income
  $ 210     $ 312     $ 894     $ 909  
 
                       
 
PER COMMON SHARE — ASSUMING DILUTION
                               
Income from continuing operations before cumulative effect of accounting change
  $ .57     $ .74     $ 2.31     $ 2.15  
(Loss) income from discontinued operations a
    (.03 )     .02       (.06 )     .05  
Cumulative effect of accounting change
                      .01  
 
Net income
  $ .54     $ .76     $ 2.25     $ 2.21  
 
                       
 
PERFORMANCE RATIOS
                               
From continuing operations:
                               
Return on average total assets
    .93 %     1.31 %     1.31 %     1.30 %
Return on average equity
    11.50       15.52       16.03       15.44  
From consolidated operations:
                               
Return on average total assets
    .88 %     1.30 %     1.28 %     1.29 %
Return on average equity
    10.79       15.88       15.59       15.82  
 
(a)   Key sold the nonprime mortgage loan portfolio held by the Champion Mortgage finance business in November 2006, and completed the sale of Champion’s origination platform in February 2007. As a result of these actions, Key has accounted for this business as a discontinued operation. The loss from discontinued operations recorded in the third quarter of 2007 was attributable largely to a write-down on the building lease for the former Champion headquarters.
As shown in Figure 2, the comparability of Key’s income from continuing operations for the three- and nine-month periods ended September 30, 2007 and 2006, is affected by several significant items, certain of which were the result of strategic actions described on page 39 that were taken to improve Key’s business mix and to reposition the balance sheet.
Figure 2. Significant Items Affecting the Comparability of Earnings
                                                                 
    Three months ended     Three months ended     Nine months ended     Nine months ended  
    September 30, 2007     September 30, 2006     September 30, 2007     September 30, 2006  
    Pre-tax     After-tax     Pre-tax     After-tax     Pre-tax     After-tax     Pre-tax     After-tax  
in millions, except per share amounts   Amount     Amount     Amount     Amount     Amount     Amount     Amount     Amount  
 
INCOME FROM CONTINUING OPERATIONS —
GAAP BASIS
  $ 310     $ 224     $ 423     $ 305     $ 1,282     $ 919     $ 1,235     $ 882  
Significant items:
                                                               
McDonald Investments branch network a
    5       3       6       4       (146 )     (92 )     23       14  
Gains related to MasterCard Incorporated shares
    (27 )     (17 )                 (67 )     (42 )     (9 )     (6 )
Litigation reserve
                            42       26              
Gain from settlement of automobile residual value insurance litigation
                            (26 )     (17 )            
Loss from repositioning of securities portfolio
                            49       31              
 
INCOME FROM CONTINUING OPERATIONS — ADJUSTED BASIS
  $ 288     $ 210     $ 429     $ 309     $ 1,134     $ 825     $ 1,249     $ 890  
 
                                               
 
                                                               
PER COMMON SHARE — ASSUMING DILUTION
                                                               
Income from continuing operations — GAAP basis
    N/M     $ .57       N/M     $ .74       N/M     $ 2.31       N/M     $ 2.15  
Income from continuing operations — adjusted basis
    N/M       .53       N/M       .75       N/M       2.07       N/M       2.17  
 
(a)   Represents the financial effect of the McDonald Investments branch network, including a gain of $171 million ($107 million after tax) from the February 9, 2007, sale of that network.
N/M = Not Meaningful
GAAP = U.S. generally accepted accounting principles

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During the first quarter of 2007, Key completed the previously announced sales of the McDonald Investments branch network and the Champion Mortgage loan origination platform. Both transactions are consistent with Key’s strategy of focusing on core relationship businesses and exiting those areas in which it does not have either the scale or opportunity to build profitable client relationships.
During the same period, Key repositioned the securities portfolio in response to changing market conditions. Management initiated this change to enhance Key’s future financial performance, particularly in the event of a decline in interest rates. For more detailed information regarding the repositioning and composition of the securities portfolio, see the section entitled “Securities,” which begins on page 58.
Key’s top four priorities for 2007 are to profitably grow revenue, institutionalize a culture of compliance and accountability, maintain a strong credit culture and improve operating leverage so that revenue growth outpaces expense growth. During the third quarter of 2007:
¨   Key’s noninterest income decreased by $105 million from the third quarter of 2006. The adverse impact of fixed income market volatility on several of Key’s capital markets-driven businesses, the sale of the McDonald Investments branch network completed in the first quarter of this year and lower net gains from principal investing activities caused the decrease. The reduction in noninterest income was moderated by a $27 million gain from the sale of MasterCard Incorporated shares in the current quarter, growth in deposit service charge income and higher income from Key’s asset management business. Net interest income decreased by $11 million from the year-ago quarter as interest rate spreads on both loans and deposits remained under pressure due to the continuation of competitive pricing. The tightening of interest rate spreads more than offset the positive effect of a 4% increase in average earning assets.
 
¨   Key’s nonperforming assets rose by $192 million and were up $241 million from the level reported one year ago. The increase was due primarily to the impact of deteriorating market conditions on the residential property segment of the commercial real estate construction portfolio with the majority of the growth coming from nonperforming loans outstanding in Florida and southern California. Outside of this portfolio, Key experienced only modest increases in nonperforming loans during the third quarter. For the third quarter of 2007, net loan charge-offs totaled $59 million, or .35% of average total loans.
 
¨   Key continued to manage expenses effectively. Key’s total noninterest expense decreased by 5% from the third quarter of 2006, largely as a result of the sale of the McDonald Investments branch network and lower incentive compensation accruals.
 
¨   Key continued to effectively manage its equity capital through dividends paid to shareholders, share repurchases and investing in its businesses. During the third quarter, Key repurchased 2.0 million of its common shares. At September 30, 2007, Key’s tangible equity to tangible assets ratio was 6.78%.
The primary reasons that Key’s revenue and expense components changed from those reported for the three- and nine-month periods ended September 30, 2006, are reviewed in greater detail throughout the remainder of the Management’s Discussion & Analysis section.
Financial outlook
During the third quarter of 2007, the fixed income markets experienced extraordinary volatility, rapidly widening credit spreads and significantly reduced liquidity. Key participates in these markets primarily through business conducted by its National Banking group and through its principal investing activities. The widening of credit spreads had an adverse impact on the market values of Key’s loans held-for-sale, trading account securities and certain real estate-related investments included in “other investments” on the balance sheet. During the third quarter of 2007, Key recorded net losses of $77 million on these assets, compared to net gains of $26 million in the third quarter of 2006. Net gains from principal investing activities were $9 million for the current quarter, down from $28 million for the same period last year.

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Although the fixed income markets continue to remain under pressure heading into the fourth quarter, management believes most of the financial impact on Key’s market-sensitive portfolios has already been experienced and expects the performance of these portfolios to improve over the remainder of the year. Based on current market conditions, management expects earnings per common share for the fourth quarter of 2007 to be in the range of $.68 to $.74. Management’s expectations for the fourth quarter of 2007 with regard to certain other financial performance measures include:
¨   a net interest margin in the low- to mid-3.30% range;
 
¨   an upper-single digit percentage increase in commercial loans, and a low-single digit percentage increase in consumer loans;
 
¨   a low- to mid-single digit percentage increase in core deposits;
 
¨   net loan charge-offs in the range of .35% to .45% of average loans; and
 
¨   an effective tax rate of approximately 32% on a taxable-equivalent basis.
Strategic developments
Key has taken a number of specific actions during 2007 and 2006 to support its corporate strategy.
¨   On October 1, 2007, Key acquired Tuition Management Systems, Inc., one of the nation’s largest providers of outsourced tuition planning, billing, counseling and payment services. Headquartered in Warwick, Rhode Island, Tuition Management Systems serves more than 700 colleges, universities, elementary and secondary educational institutions. The payment plan systems and technology in place at Tuition Management Systems and the array of payment plan products offered by Key will create one of the largest payment plan providers in the nation.
 
¨   On July 27, 2007, Key entered into an agreement to acquire U.S.B. Holding Co., Inc., the holding company for Union State Bank, a state-chartered commercial bank headquartered in Orangeburg, New York, with 31 branches. U.S.B. Holding Co. has assets of approximately $3 billion and deposits of approximately $2 billion. This acquisition will expand Key’s presence in markets both within and contiguous to its current operations in the Hudson Valley. See Note 3 (“Acquisitions and Divestitures”), which begins on page 11, for more information pertaining to this pending acquisition.
 
¨   On February 9, 2007, McDonald Investments Inc., a wholly-owned subsidiary of KeyCorp, sold its branch network, which included approximately 570 financial advisors and field support staff, and certain fixed assets. Key has retained the corporate and institutional businesses, including Institutional Equities and Equity Research, Debt Capital Markets and Investment Banking. In addition, KeyBank continues to operate the Wealth Management, Trust and Private Banking businesses. On April 16, 2007, Key renamed its registered broker/dealer through which its corporate and institutional investment banking and securities businesses operate. The new name is KeyBanc Capital Markets Inc.
 
¨   On November 29, 2006, Key sold the nonprime mortgage loan portfolio held by the Champion Mortgage finance business. Key completed the sale of the Champion loan origination platform on February 28, 2007.
 
¨   On April 1, 2006, Key broadened its asset management product line by acquiring Austin Capital Management, Ltd., an investment firm headquartered in Austin, Texas with approximately $900 million in assets under management at the date of acquisition. Austin specializes in selecting and managing hedge fund investments for its principally institutional customer base.

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Figure 3. Selected Financial Data
                                                         
                                            Nine months ended  
    2007     2006     September 30,  
dollars in millions, except per share amounts   Third     Second     First     Fourth     Third     2007     2006  
 
FOR THE PERIOD
                                                       
Interest income
  $ 1,434     $ 1,395     $ 1,368     $ 1,413     $ 1,389     $ 4,197     $ 3,967  
Interest expense
    740       709       689       701       684       2,138       1,864  
Net interest income
    694       686       679       712       705       2,059       2,103  
Provision for loan losses
    69       53       44       53       35       166       97  
Noninterest income
    438       649       654       558       543       1,741       1,569  
Noninterest expense
    753       815       784       809       790       2,352       2,340  
Income from continuing operations before income taxes and cumulative effect of accounting change
    310       467       505       408       423       1,282       1,235  
Income from continuing operations before cumulative effect of accounting change
    224       337       358       311       305       919       882  
(Loss) income from discontinued operations, net of taxes
    (14 )     (3 )     (8 )     (165 )     7       (25 )     22  
Income before cumulative effect of accounting change
    210       334       350       146       312       894       904  
Net income
    210       334       350       146       312       894       909  
 
PER COMMON SHARE
                                                       
Income from continuing operations before cumulative effect of accounting change
  $ .58     $ .86     $ .90     $ .77     $ .76     $ 2.34     $ 2.18  
(Loss) income from discontinued operations
    (.03 )     (.01 )     (.02 )     (.41 )     .02       (.06 )     .05  
Income before cumulative effect of accounting change
    .54       .85       .88       .36       .77       2.28       2.23  
Net income
    .54       .85       .88       .36       .77       2.28       2.24  
 
Income from continuing operations before cumulative effect of accounting change
— assuming dilution
    .57       .85       .89       .76       .74       2.31       2.15  
(Loss) income from discontinued operations — assuming dilution
    (.03 )     (.01 )     (.02 )     (.40 )     .02       (.06 )     .05  
Income before cumulative effect of accounting change — assuming dilution
    .54       .84       .87       .36       .76       2.25       2.20  
Net income — assuming dilution
    .54       .84       .87       .36       .76       2.25       2.21  
 
                                                       
Cash dividends declared
    .365       .365       .365       .345       .345       1.095       1.035  
Book value at period end
    20.12       19.78       19.57       19.30       19.73       20.12       19.73  
Market price:
                                                       
High
    37.09       38.96       39.90       38.63       38.15       39.90       38.31  
Low
    31.38       34.15       35.94       35.73       34.48       31.38       32.68  
Close
    32.33       34.33       37.47       38.03       37.44       32.33       37.44  
Weighted-average common shares outstanding (000)
    389,319       392,045       397,875       402,329       403,780       393,048       405,218  
Weighted-average common shares and potential common shares outstanding (000)
    393,164       396,918       403,478       407,828       409,428       397,816       411,029  
 
AT PERIOD END
                                                       
Loans
  $ 68,999     $ 66,692     $ 65,711     $ 65,826     $ 65,551     $ 68,999     $ 65,551  
Earning assets
    84,973       82,328       81,263       80,090       83,132       84,973       83,132  
Total assets
    97,366       94,076       93,219       92,337       96,155       97,366       96,155  
Deposits
    63,714       60,599       59,773       59,116       61,429       63,714       61,429  
Long-term debt
    11,549       12,581       13,061       14,533       13,654       11,549       13,654  
Shareholders’ equity
    7,820       7,701       7,719       7,703       7,947       7,820       7,947  
 
PERFORMANCE RATIOS
                                                       
From continuing operations:
                                                       
Return on average total assets
    .93 %     1.45 %     1.58 %     1.33 %     1.31 %     1.31 %     1.30 %
Return on average equity
    11.50       17.66       19.06       15.63       15.52       16.03       15.44  
Net interest margin (taxable equivalent)
    3.40       3.46       3.50       3.66       3.61       3.46       3.67  
From consolidated operations:
                                                       
Return of average total assets
    .88 %     1.43 %     1.54 %     .61 %     1.30 %     1.28 %     1.29 %
Return of average equity
    10.79       17.50       18.63       7.34       15.88       15.59       15.82  
Net interest margin (taxable equivalent)
    3.40       3.46       3.51       3.69       3.63       3.46       3.69  
 
CAPITAL RATIOS AT PERIOD END
                                                       
Equity to assets
    8.03 %     8.19 %     8.28 %     8.34 %     8.26 %     8.03 %     8.26 %
Tangible equity to tangible assets
    6.78       6.89       6.97       7.01       6.81       6.78       6.81  
Tier 1 risk-based capital
    7.94       8.14       8.15       8.24       8.02       7.94       8.02  
Total risk-based capital
    11.76       12.15       12.20       12.43       12.13       11.76       12.13  
Leverage
    8.96       9.11       9.17       8.98       8.89       8.96       8.89  
 
TRUST AND BROKERAGE ASSETS
                                                       
Assets under management
  $ 88,100     $ 85,592     $ 82,388     $ 84,699     $ 84,060     $ 88,100     $ 84,060  
Nonmanaged and brokerage assets
    33,273       33,485       32,838       56,292       55,221       33,273       55,221  
 
OTHER DATA
                                                       
Average full-time equivalent employees
    18,567       18,888       19,801       20,100       20,264       19,081       19,974  
Branches
    954       954       950       950       949       954       949  
 
Acquisitions and divestitures completed by Key during the periods shown in this table may have had a significant effect on Key’s results, making it difficult to compare results from one period to the next. Note 3 (“Acquisitions and Divestitures”), which begins on page 11, contains specific information about the acquisition and divestitures that Key completed during 2006 and the first nine months of 2007 to help in understanding how those transactions may have impacted Key’s financial condition and results of operations.

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Line of Business Results
This section summarizes the financial performance and related strategic developments of Key’s two major business groups: Community Banking and National Banking. To better understand this discussion, see Note 4 (“Line of Business Results”), which begins on page 13. Note 4 describes the products and services offered by each of these business groups, provides more detailed financial information pertaining to the groups and their respective lines of business, and explains “Other Segments” and “Reconciling Items.”
Figure 4 summarizes the contribution made by each major business group to Key’s taxable-equivalent revenue and income from continuing operations for the three- and nine-month periods ended September 30, 2007 and 2006. Key’s line of business results for each of these periods reflect a new organizational structure that took effect January 1, 2007.
Figure 4. Major Business Groups — Taxable-Equivalent Revenue and Income from Continuing Operations
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
REVENUE FROM CONTINUING OPERATIONS (TE) a
                                                               
Community Banking
  $ 626     $ 687     $ (61 )     (8.9) %   $ 2,060     $ 2,023     $ 37       1.8 %
National Banking
    511       586       (75 )     (12.8 )     1,727       1,748       (21 )     (1.2 )
Other Segments
    14       25       (11 )     (44.0 )     95       38       57       150.0  
 
Total Segments
    1,151       1,298       (147 )     (11.3 )     3,882       3,809       73       1.9  
Reconciling Items
    (1 )     (29 )     28       96.6       (23 )     (66 )     43       65.2  
 
Total
  $ 1,150     $ 1,269     $ (119 )     (9.4) %   $ 3,859     $ 3,743     $ 116       3.1 %
 
                                               
 
                                                               
INCOME FROM CONTINUING OPERATIONS a
                                                               
Community Banking
  $ 131     $ 112     $ 19       17.0 %   $ 430     $ 323     $ 107       33.1 %
National Banking
    72       169       (97 )     (57.4 )     393       509       (116 )     (22.8 )
Other Segments
    16       20       (4 )     (20.0 )     62       39       23       59.0  
 
Total Segments
    219       301       (82 )     (27.2 )     885       871       14       1.6  
Reconciling Items
    5       4       1       25.0       34       11       23       209.1  
 
Total
  $ 224     $ 305     $ (81 )     (26.6) %   $ 919     $ 882     $ 37       4.2 %
 
                                               
 
(a)   Community Banking results for the first nine months of 2007 include a $171 million ($107 million after tax) gain from the February 9, 2007, sale of the McDonald Investments branch network. See Note 3 (“Acquisitions and Divestitures”), which begins on page 11, for more information pertaining to this transaction.
 
    National Banking results for the first nine months of 2007 include a $26 million ($17 million after tax) gain from the settlement of the residual value insurance litigation during the first quarter.
 
    Other Segments’ results for the first nine months of 2007 include a $26 million ($16 million after tax) charge for litigation recorded during the second quarter. This charge and the litigation charge referred to in the comment related to Reconciling Items below comprise the $42 million charge recorded in connection with the Honsador litigation disclosed in Note 13 (“Contingent Liabilities and Guarantees”), which begins on page 28. Results for the current year-to-date period also include a $49 million ($31 million after tax) loss recorded during the first quarter in connection with the repositioning of the securities portfolio.
 
 
    Reconciling Items include gains of $27 million ($17 million after tax) recorded during the third quarter of 2007, $40 million ($25 million after tax) recorded during the second quarter of 2007 and $9 million ($6 million after tax) recorded during the second quarter of 2006 related to MasterCard Incorporated shares. Results for the first nine months of 2007 also include a $16 million ($10 million after tax) charge for litigation recorded during the second quarter.
TE = Taxable Equivalent
Community Banking summary of operations
As shown in Figure 5, net income for Community Banking was $131 million for the third quarter of 2007, up from $112 million for the year-ago quarter. Declines in both net interest income and noninterest income were more than offset by decreases in the provision for loan losses and noninterest expense.

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Taxable-equivalent net interest income decreased by $34 million, or 8%, from the third quarter of 2006, as interest rate spreads on both average earning assets and deposits have remained under pressure due to the continuation of competitive pricing. The decrease also reflected the effect of the February 2007 sale of the McDonald Investments branch network in which Key transferred approximately $1.3 billion of Negotiable Order of Withdrawal (“NOW”) and money market deposit accounts to the buyer. McDonald Investments’ NOW and money market deposit accounts averaged $1.7 billion for the third quarter of 2006.
Noninterest income decreased by $27 million, or 11%. The decrease was attributable to the McDonald Investments sale. Excluding the impact of this sale, noninterest income rose by $13 million, or 6%, from the same period one year ago, due largely to growth in deposit service charge income.
The provision for loan losses decreased by $21 million, compared to the third quarter of 2006.
Noninterest expense declined by $69 million, or 14%, from the year-ago quarter. Reductions in costs resulting from the sale of the McDonald Investments branch network accounted for $46 million of the decline, including a $27 million decrease in personnel expense. The remainder of the decline in total noninterest expense reflected decreases in various direct and indirect charges, due in part to a reduction in the number of average full-time equivalent employees.
On July 27, 2007, Key entered into an agreement to acquire U.S.B. Holding Co., Inc., the holding company for Union State Bank, a state-chartered commercial bank headquartered in Orangeburg, New York, with 31 branches. U.S.B. Holding Company has assets of approximately $3 billion and deposits of approximately $2 billion. Key expects to complete this acquisition early in 2008, subject to approval by U.S.B. Holding Company shareholders and the banking regulators. The acquisition will expand Key’s presence in markets both within and contiguous to its current operations in the Hudson Valley. See Note 3 (“Acquisitions and Divestitures”), which begins on page 11, for more information pertaining to this transaction.
Figure 5. Community Banking
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
SUMMARY OF OPERATIONS
                                                               
Net interest income (TE)
  $ 409     $ 443     $ (34 )     (7.7 )%   $ 1,242     $ 1,309     $ (67 )     (5.1 )%
Noninterest income
    217       244       (27 )     (11.1 )     818  a     714       104       14.6  
 
Total revenue (TE)
    626       687       (61 )     (8.9 )     2,060       2,023       37       1.8  
Provision for loan losses
    1       22       (21 )     (95.5 )     36       71       (35 )     (49.3 )
Noninterest expense
    417       486       (69 )     (14.2 )     1,336       1,435       (99 )     (6.9 )
 
Income before income taxes (TE)
    208       179       29       16.2       688       517       171       33.1  
Allocated income taxes and TE adjustments
    77       67       10       14.9       258       194       64       33.0  
 
Net income
  $ 131     $ 112     $ 19       17.0 %   $ 430     $ 323     $ 107       33.1 %
 
                                               
 
                                                               
Percent of consolidated income from continuing operations
    59 %     37 %     N/A       N/A       47 %     37 %     N/A       N/A  
 
                                                               
AVERAGE BALANCES
                                                               
Loans and leases
  $ 26,947     $ 26,794     $ 153       .6 %   $ 26,661     $ 26,803     $ (142 )     (.5 )%
Total assets
    29,716       29,871       (155 )     (.5 )     29,454       29,883       (429 )     (1.4 )
Deposits
    46,727       46,939       (212 )     (.5 )     46,458       46,459       (1 )      
 
(a)   Community Banking results for the first nine months of 2007 include a $171 million ($107 million after tax) gain from the February 9, 2007, sale of the McDonald Investments branch network. See Note 3 (“Acquisitions and Divestitures”), which begins on page 11, for more information pertaining to this transaction.
TE = Taxable Equivalent
N/A = Not Applicable

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ADDITIONAL COMMUNITY BANKING DATA
                                                                     
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
AVERAGE DEPOSITS OUTSTANDING
                                                               
NOW and money market deposit accounts
  $ 20,305     $ 20,688     $ (383 )     (1.9 )%   $ 19,632     $ 20,564     $ (932 )     (4.5 )%
Savings deposits
    1,569       1,688       (119 )     (7.0 )     1,602       1,721       (119 )     (6.9 )
Certificates of deposits ($100,000 or more)
    4,566       4,101       465       11.3       4,609       4,023       586       14.6  
Other time deposits
    11,485       11,696       (211 )     (1.8 )     11,856       11,472       384       3.3  
Deposits in foreign office
    1,128       694       434       62.5       1,044       617       427       69.2  
Noninterest-bearing deposits
    7,674       8,072       (398 )     (4.9 )     7,715       8,062       (347 )     (4.3 )
 
Total deposits
  $ 46,727     $ 46,939     $ (212 )     (.5 )%   $ 46,458     $ 46,459     $ (1 )      
 
                                               
 
HOME EQUITY LOANS
                                                               
Average balance
  $ 9,690     $ 10,048                                                  
Weighted-average loan-to-value ratio
    70 %     70 %                                                
Percent first lien positions
    58       60                                                  
                                                 
OTHER DATA
                                                               
On-line households/household penetration
    743,909 / 45 %     646,993 / 52 %                                                
Branches
    954       949                                                  
Automated teller machines
    1,439       2,099                                                  
                                                 
National Banking summary of continuing operations
As shown in Figure 6, income from continuing operations for National Banking was $72 million for the third quarter of 2007, compared to $169 million for the same period last year. Lower noninterest income along with increases in the provision for loan losses and noninterest expense accounted for the reduction, and more than offset an increase in net interest income.
Taxable-equivalent net interest income rose by $11 million, or 3%, from the third quarter of 2006. Increases in average earning assets and deposits, and a more favorable interest rate spread on deposits more than offset the adverse effect of a tighter interest rate spread on average earning assets.
Noninterest income declined by $86 million, or 36%, as several capital markets-driven businesses were adversely affected by volatility in the financial markets. Results for the current quarter included net losses of $57 million from the sales and write-downs of primarily commercial real estate loans held for sale, compared to net gains of $10 million for the year-ago quarter. Income from investment banking and capital markets activities decreased by $39 million, due primarily to a $25 million decline in the fair values of two real estate-related investments held by the Private Equity unit within the Real Estate Capital line of business, and less favorable results related to trading activities conducted in the Debt Capital markets area.
The provision for loan losses rose by $55 million, reflecting increases in nonperforming loans in the Real Estate Capital and Consumer Finance lines of business.
Noninterest expense grew by $24 million, or 8%, from the year-ago quarter, reflecting a $12 million rise in costs associated with operating leases, and smaller increases in a variety of other expense components.
On October 1, 2007, Key acquired Tuition Management Systems, Inc., one of the nation’s largest providers of outsourced tuition planning, billing, counseling and payment services. Headquartered in Warwick, Rhode Island, Tuition Management Systems serves more than 700 colleges, universities, elementary and secondary educational institutions. The payment plan systems and technology in place at Tuition Management Systems and the array of payment plan products offered by Key will create one of the largest payment plan providers in the nation.

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Figure 6. National Banking
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
SUMMARY OF OPERATIONS
                                                               
Net interest income (TE)
  $ 359     $ 348     $ 11       3.2 %   $ 1,045     $ 1,039     $ 6       .6 %
Noninterest income
    152       238       (86 )     (36.1 )     682  a     709       (27 )     (3.8 )
 
Total revenue (TE)
    511       586       (75 )     (12.8 )     1,727       1,748       (21 )     (1.2 )
Provision for loan losses
    68       13       55       423.1       130       26       104       400.0  
Noninterest expense
    328       304       24       7.9       968       912       56       6.1  
 
Income from continuing operations before income taxes (TE)
    115       269       (154 )     (57.2 )     629       810       (181 )     (22.3 )
Allocated income taxes and TE adjustments
    43       100       (57 )     (57.0 )     236       301       (65 )     (21.6 )
 
Income from continuing operations
    72       169       (97 )     (57.4 )     393       509       (116 )     (22.8 )
(Loss) income from discontinued operations, net of taxes
    (14 )     7       (21 )     N/M       (25 )     22       (47 )     N/M  
 
Net income
  $ 58     $ 176     $ (118 )     (67.0 )%   $ 368     $ 531     $ (163 )     (30.7 )%
 
                                               
 
                                                               
Percent of consolidated income from continuing operations
    32 %     55 %     N/A       N/A       43 %     58 %     N/A       N/A  
 
                                                               
AVERAGE BALANCES FROM CONTINUING OPERATIONS
                                                               
Loans and leases
  $ 40,277     $ 37,871     $ 2,406       6.4 %   $ 39,485     $ 37,545     $ 1,940       5.2 %
Loans held for sale
    4,692       4,553       139       3.1       4,331       4,022       309       7.7  
Total assets
    50,954       48,530       2,424       5.0       49,665       47,659       2,006       4.2  
Deposits
    12,633       11,106       1,527       13.7       12,009       10,597       1,412       13.3  
 
(a)   National Banking results for the first nine months of 2007 include a $26 million ($17 million after tax) gain from the settlement of the residual value insurance litigation during the first quarter.
TE = Taxable Equivalent
N/A = Not Applicable
N/M = Not Meaningful
Other Segments
Other segments consist of Corporate Treasury and Key’s Principal Investing unit. These segments generated net income of $16 million for the third quarter of 2007, compared to $20 million for the same period last year. A reduction in net gains from principal investing caused the decrease.

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Results of Operations
Net interest income
One of Key’s principal sources of revenue is net interest income. Net interest income is the difference between interest income received on earning assets (such as loans and securities) and loan-related fee income, and interest expense paid on deposits and borrowings. There are several factors that affect net interest income, including:
¨ the volume, pricing, mix and maturity of earning assets and interest-bearing liabilities;
¨ the volume and value of net free funds, such as noninterest-bearing deposits and equity capital;
¨ the use of derivative instruments to manage interest rate risk;
¨ interest rate fluctuations and competitive conditions within the marketplace; and
¨ asset quality.
To make it easier to compare results among several periods and the yields on various types of earning assets (some taxable, some not), we present net interest income in this discussion on a “taxable-equivalent basis” (i.e., as if it were all taxable and at the same rate). For example, $100 of tax-exempt income would be presented as $154, an amount that—if taxed at the statutory federal income tax rate of 35%—would yield $100.
Figure 7, which spans pages 48 and 49, shows the various components of Key’s balance sheet that affect interest income and expense, and their respective yields or rates over the past five quarters. This figure also presents a reconciliation of taxable-equivalent net interest income for each of those quarters to net interest income reported in accordance with GAAP.
Taxable-equivalent net interest income was $712 million for the third quarter of 2007, compared to $726 million for the year-ago quarter. The net interest margin, which is an indicator of the profitability of the earning assets portfolio, is calculated by dividing net interest income by average earning assets. Key’s net interest margin declined by 21 basis points from the third quarter of 2006 to 3.40% for the third quarter of 2007. A basis point is equal to one one-hundredth of a percentage point, meaning 21 basis points equal .21%.
The reductions in net interest income and the net interest margin were due primarily to tighter interest rate spreads on both loans and deposits, reflecting the continuation of competitive pricing, and client preferences for deposit products with more attractive interest rates. Additionally, as part of the February 2007 sale of the McDonald Investments branch network, Key transferred approximately $1.3 billion of NOW and money market deposit accounts to the buyer. McDonald Investments’ NOW and money market deposit accounts averaged $1.7 billion for the third quarter of 2006. The decrease in the net interest margin was moderated by the impact of a 14% rise in the volume of noninterest-bearing funds. The growth in these funds added approximately 12 basis points to the net interest margin.
Average earning assets for the third quarter of 2007 totaled $83.5 billion, which was $3.6 billion, or 4%, higher than the third quarter 2006 level. Increases in commercial loans and securities available for sale drove the growth.

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Since December 31, 2005, the growth and composition of Key’s earning assets have been affected by the following loan sales, most of which came from the held-for-sale portfolio:
¨    Key sold commercial mortgage loans of $2.8 billion ($238 million through a securitization) during the first nine months of 2007 and $2.6 billion during all of 2006. Since some of these loans have been sold with limited recourse (i.e., there is a risk that Key will be held accountable for certain events or representations made in the sales agreements), Key established and has maintained a loss reserve in an amount estimated by management to be appropriate. More information about the related recourse agreement is provided in Note 13 (“Contingent Liabilities and Guarantees”) under the heading “Recourse agreement with Federal National Mortgage Association” on page 29.
 
¨    Key sold education loans of $223 million during the first nine months of 2007 and $1.4 billion ($1.1 billion through a securitization) during all of 2006. Key uses the securitization market for education loans to diversify funding sources.
 
¨    Key sold other loans totaling $874 million during the first nine months of 2007 and $3.2 billion during all of 2006. This included the fourth quarter 2006 sale of the $2.5 billion nonprime mortgage loan portfolio held by the Champion Mortgage finance business. The Champion business no longer fit strategically with Key’s longer-term business goals and continued focus on Community Banking and relationship-oriented businesses.

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Figure 7. Average Balance Sheets, Net Interest Income and Yields/Rates
From Continuing Operations
                                                 
    Third Quarter 2007     Second Quarter 2007  
    Average             Yield/     Average             Yield/  
dollars in millions   Balance     Interest     Rate     Balance     Interest     Rate  
 
ASSETS
                                               
Loans a,b
                                               
Commercial, financial and agricultural
  $ 22,393     $ 410       7.25 %   $ 21,856     $ 401       7.36 %
Real estate — commercial mortgage
    8,855       172       7.69       8,565       165       7.75  
Real estate — construction
    8,285       167       8.01       8,243       167       8.09  
Commercial lease financing
    10,172       147       5.80       10,096       142       5.62  
 
Total commercial loans
    49,705       896       7.16       48,760       875       7.19  
Real estate — residential
    1,586       26       6.68       1,472       24       6.57  
Home equity
    10,883       199       7.22       10,752       193       7.22  
Consumer — direct
    1,342       36       10.66       1,370       37       10.64  
Consumer — indirect
    4,164       70       6.79       3,961       67       6.76  
 
Total consumer loans
    17,975       331       7.33       17,555       321       7.33  
 
Total loans
    67,680       1,227       7.20       66,315       1,196       7.23  
Loans held for sale
    4,731       91       7.59       4,415       82       7.50  
Investment securities a
    36             6.43       39             6.72  
Securities available for sale c
    7,825       106       5.45       7,793       106       5.45  
Short-term investments
    1,688       16       3.99       1,484       16       4.19  
Other investments c
    1,563       12       2.99       1,541       15       3.68  
 
Total earning assets
    83,523       1,452       6.92       81,587       1,415       6.95  
Allowance for loan losses
    (942 )                     (942 )                
Accrued income and other assets
    12,581                       12,767                  
 
 
                                               
Total assets
  $ 95,162                     $ 93,412                  
 
                                           
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
                                               
NOW and money market deposit accounts
  $ 24,190       209       3.41     $ 22,953       179       3.14  
Savings deposits
    1,581             .19       1,633       1       .19  
Certificates of deposit ($100,000 or more) d
    6,274       80       5.06       6,237       79       5.03  
Other time deposits
    11,512       136       4.68       12,047       141       4.70  
Deposits in foreign office e
    4,540       57       5.00       3,600       47       5.20  
 
Total interest-bearing deposits
    48,097       482       3.98       46,470       447       3.85  
Federal funds purchased and securities sold under repurchase agreements e
    4,470       55       4.85       4,748       59       5.04  
Bank notes and other short-term borrowings
    2,539       30       4.70       1,771       18       4.14  
Long-term debt d, e
    11,801       173       5.89       12,909       185       5.83  
 
Total interest-bearing liabilities
    66,907       740       4.40       65,898       709       4.33  
Noninterest-bearing deposits
    14,424                       13,927                  
Accrued expense and other liabilities
    6,106                       5,933                  
Shareholders’ equity
    7,725                       7,654                  
 
 
Total liabilities and shareholders’ equity
  $ 95,162                     $ 93,412                  
 
                                           
 
                                               
Interest rate spread (TE)
                    2.52 %                     2.62 %
 
Net interest income (TE) and net interest margin (TE)
            712       3.40 %             706       3.46 %
 
                                           
TE adjustment a
            18                       20          
 
Net interest income, GAAP basis
          $ 694                     $ 686          
 
                                           
 
(a)   Interest income on tax-exempt securities and loans has been adjusted to a taxable-equivalent basis using the statutory federal
 
    income tax rate of 35%.
 
(b)   For purposes of these computations, nonaccrual loans are included in average loan balances.
 
(c)   Yield is calculated on the basis of amortized cost.
 
(d)   Rate calculation excludes basis adjustments related to fair value hedges.
 
(e)   Results from continuing operations exclude the dollar amount of liabilities assumed necessary to support interest-earning assets held by the discontinued Champion Mortgage finance business. The interest expense related to these liabilities, which also is excluded from continuing operations, was calculated using a matched funds transfer pricing methodology.
 
TE = Taxable Equivalent
 
GAAP = U.S. generally accepted accounting principles

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Figure 7. Average Balance Sheets, Net Interest Income and Yields/Rates
From Continuing Operations (Continued)
                                                                         
    First Quarter 2007     Fourth Quarter 2006     Third Quarter 2006  
    Average             Yield/     Average             Yield/     Average             Yield/  
    Balance     Interest     Rate     Balance     Interest     Rate     Balance     Interest     Rate  
     
 
                                                                   
 
                                                                   
 
  $ 21,562     $ 392       7.38 %   $ 21,384     $ 400       7.42 %   $ 21,648     $ 400       7.34 %
 
    8,426       163       7.83       8,399       167       7.86       8,106       164       8.04  
 
    8,227       166       8.20       8,347       174       8.25       7,965       171       8.51  
 
    10,094       146       5.78       9,891       160       6.47       9,850       144       5.83  
     
 
    48,309       867       7.26       48,021       901       7.44       47,569       879       7.34  
 
    1,444       24       6.60       1,428       24       6.59       1,415       23       6.49  
 
    10,706       191       7.22       10,896       197       7.22       11,017       200       7.19  
 
    1,450       36       10.15       1,557       34       8.63       1,585       36       9.07  
 
    3,760       64       6.79       3,671       62       6.85       3,594       61       6.83  
     
 
    17,360       315       7.32       17,552       317       7.21       17,611       320       7.23  
     
 
    65,669       1,182       7.28       65,573       1,218       7.38       65,180       1,199       7.31  
 
    3,940       75       7.70       4,547       90       7.86       4,578       94       8.17  
 
    39       1       7.21       38       1       7.68       42       1       8.12  
 
    7,548       100       5.27       7,765       96       4.88       7,216       84       4.61  
 
    1,607       18       4.55       1,584       16       4.04       1,588       16       3.78  
 
    1,400       13       3.65       1,351       24       6.76       1,363       16       4.67  
     
 
    80,203       1,389       6.99       80,858       1,445       7.09       79,967       1,410       7.00  
 
    (942 )                     (941 )                     (951 )                
 
    12,835                       13,129                       13,247                  
     
 
                                               
 
  $ 92,096                     $ 93,046                     $ 92,263                  
 
                                                                 
 
                                                                       
 
                                                                       
 
  $ 23,424       177       3.06     $ 25,136       198       3.13     $ 25,230       194       3.05  
 
    1,629       1       .19       1,651       1       .19       1,700       1       .19  
 
    6,151       76       5.03       6,013       75       4.93       5,517       67       4.82  
 
    12,063       138       4.64       11,921       136       4.50       11,700       127       4.29  
 
    3,258       41       5.12       2,245       30       5.55       2,820       39       5.55  
     
 
    46,525       433       3.77       46,966       440       3.72       46,967       428       3.61  
 
                                                                       
 
    3,903       49       5.04       2,816       37       5.21       2,315       30       5.05  
 
    1,113       11       3.98       1,814       19       4.17       2,285       24       4.29  
 
    13,617       196       5.90       14,092       205       5.80       13,763       202       5.83  
     
 
    65,158       689       4.29       65,688       701       4.24       65,330       684       4.15  
 
    13,237                       13,424                       13,073                  
 
    6,083                       6,041                       6,063                  
 
    7,618                       7,893                       7,797                  
     
 
                                                                       
 
  $ 92,096                     $ 93,046                     $ 92,263                  
 
                                                                 
 
                                                                       
 
                    2.70 %                     2.85 %                   2.85 %
     
 
            700       3.50 %             744       3.66 %             726       3.61 %
 
                                                                 
 
            21                       32                       21          
     
 
          $ 679                     $ 712                     $ 705          
 
                                                                 
     

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Figure 8 shows how the changes in yields or rates and average balances from the prior year affected net interest income. The section entitled “Financial Condition,” which begins on page 55, contains more discussion about changes in earning assets and funding sources.
Figure 8. Components of Net Interest Income Changes
                                                 
    From three months ended September 30, 2006   From nine months ended September 30, 2006
    to three months ended September 30, 2007   to nine months ended September 30, 2007
    Average     Yield/     Net     Average     Yield/     Net  
in millions   Volume     Rate     Change     Volume     Rate     Change  
 
INTEREST INCOME
                                               
Loans
  $ 46     $ (18 )   $ 28     $ 95     $ 65     $ 160  
Loans held for sale
    3       (6 )     (3 )     19       (6 )     13  
Investment securities
          (1 )     (1 )     (1 )           (1 )
Securities available for sale
    7       15       22       21       40       61  
Short-term investments
    1       (1 )           (2 )     5       3  
Other investments
    2       (6 )     (4 )     5       (23 )     (18 )
 
Total interest income (TE)
    59       (17 )     42       137       81       218  
 
                                               
INTEREST EXPENSE
                                               
NOW and money market deposit accounts
    (8 )     23       15       (32 )     85       53  
Savings deposits
          (1 )     (1 )           (1 )     (1 )
Certificates of deposit ($100,000 or more)
    10       3       13       28       21       49  
Other time deposits
    (2 )     11       9       12       58       70  
Deposits in foreign office
    22       (4 )     18       56       (1 )     55  
 
Total interest-bearing deposits
    22       32       54       64       162       226  
Federal funds purchased and securities sold under repurchase agreements
    27       (2 )     25       88       5       93  
Bank notes and other short-term borrowings
    3       3       6       (20 )     4       (16 )
Long-term debt
    (29 )           (29 )     (50 )     21       (29 )
 
Total interest expense
    23       33       56       82       192       274  
 
Net interest income (TE)
  $ 36     $ (50 )   $ (14 )   $ 55     $ (111 )   $ (56 )
 
                                   
 
The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.
TE = Taxable Equivalent
Noninterest income
Noninterest income for the third quarter of 2007 was $438 million, compared to $543 million for the same period last year. For the first nine months of the year, noninterest income was $1.7 billion, representing an increase of $172 million, or 11%, from the first nine months of 2006.
The decrease from the year-ago quarter was attributable to the impact of market volatility on several of Key’s capital markets-driven businesses, as well as the sale of the McDonald Investments branch network completed in the first quarter of this year. As shown in Figure 9, results for the current quarter included $53 million in net losses from the sales and write-downs of primarily commercial real estate loans held for sale, compared to net gains of $14 million for the same period last year. Income from investment banking and capital markets activities decreased by $35 million, due primarily to a $25 million decline in the fair values of two real estate-related investments held by the Private Equity unit within the Real Estate Capital line of business. Net gains from principal investing declined by $19 million from the third quarter of 2006, and trust and investment services income was down $18 million, due to lower brokerage income resulting from the sale of the McDonald Investments branch network. The reduction in noninterest income was moderated by a $27 million gain from the sale of MasterCard Incorporated shares in the current quarter and growth in deposit service charge income.
For the year-to-date period, the growth in noninterest income from the same period last year reflected several significant items. During the first quarter of 2007, Key recorded a $171 million gain associated with the February 9, 2007, sale of the McDonald Investments branch network, a $49 million loss recorded in connection with the repositioning of the securities portfolio and a $26 million gain from the settlement of the automobile residual value insurance litigation. Excluding these items, Key’s noninterest income was $1.6 billion for the first nine months of 2007, representing a $24 million increase from the first nine months

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of 2006. As shown in Figure 9, an $80 million increase in net gains from principal investing, a $58 million increase in gains associated with the sale of MasterCard Incorporated shares, higher income from operating leases, and an increase in deposit service charge income drove the growth. These positive results were substantially offset by decreases in income from trust and investment services, and investment banking and capital markets activities. In addition, Key recorded net losses from loan securitizations and sales in the current year, compared to net gains for the first nine months of 2006.
Figure 9. Noninterest Income
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
Trust and investment services income
  $ 119     $ 137     $ (18 )     (13.1 )%   $ 359     $ 411     $ (52 )     (12.7 )%
Service charges on deposit accounts
    88       78       10       12.8       247       227       20       8.8  
Investment banking and capital markets income
    9       44       (35 )     (79.5 )     105       161       (56 )     (34.8 )
Operating lease income
    70       58       12       20.7       200       166       34       20.5  
Letter of credit and loan fees
    51       48       3       6.3       134       133       1       .8  
Corporate-owned life insurance income
    27       23       4       17.4       84       74       10       13.5  
Electronic banking fees
    25       27       (2 )     (7.4 )     74       78       (4 )     (5.1 )
Net gains (losses) from loan securitizations and sales
    (53 )     14       (67 )     N/M       (11 )     34       (45 )     N/M  
Net securities gains (losses)
    4       (7 )     11       N/M       (41 )     (2 )     (39 )     N/M  
Gain on sale of McDonald Investments branch network
                            171             171       N/M  
Other income:
                                                               
Insurance income
    16       18       (2 )     (11.1 )     45       49       (4 )     (8.2 )
Loan securitization servicing fees
    5       5                   16       15       1       6.7  
Credit card fees
    4       8       (4 )     (50.0 )     10       14       (4 )     (28.6 )
Net gains from principal investing
    9       28       (19 )     (67.9 )     128       48       80       166.7  
Gains related to MasterCard Incorporated shares
    27             27       N/M       67       9       58       644.4  
Litigation settlement — automobile residual value insurance
                            26             26       N/M  
Miscellaneous income
    37       62       (25 )     (40.3 )     127       152       (25 )     (16.4 )
 
Total other income
    98       121       (23 )     (19.0 )     419       287       132       46.0  
 
Total noninterest income
  $ 438     $ 543     $ (105 )     (19.3 )%   $ 1,741     $ 1,569     $ 172       11.0 %
 
                                                   
 
N/M = Not Meaningful
The following discussion explains the composition of certain elements of Key’s noninterest income and the factors that caused those elements to change.
Trust and investment services income. Trust and investment services generally is Key’s largest source of noninterest income. The primary components of revenue generated by these services are shown in Figure 10. The decreases compared to 2006 results were attributable to lower brokerage income resulting from the sale of the McDonald Investments branch network. Excluding the impact of the sale, brokerage commissions and fee income was up $3 million from the third quarter of last year and $5 million from the first nine months of 2006. As shown in Figure 10, growth was also experienced in both personal and institutional asset management and custody fees.
Figure 10. Trust and Investment Services Income
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
Brokerage commissions and fee income
  $ 26     $ 56     $ (30 )     (53.6 )%   $ 94     $ 177     $ (83 )     (46.9 )%
Personal asset management and custody fees
    41       39       2       5.1       122       116       6       5.2  
Institutional asset management and custody fees
    52       42       10       23.8       143       118       25       21.2  
 
Total trust and investment services income
  $ 119     $ 137     $ (18 )     (13.1 )%   $ 359     $ 411     $ (52 )     (12.7 )%
 
                                                   
 
A significant portion of Key’s trust and investment services income depends on the value and mix of assets under management. At September 30, 2007, Key’s bank, trust and registered investment advisory subsidiaries had assets under management of $88.1 billion, compared to $84.1 billion at September 30, 2006. As shown in Figure 11, the increase was due primarily to Key’s equity portfolio, reflecting improvement in the equity markets in general. Key’s fixed income portfolio and the higher-yielding hedge

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funds also contributed to the increase. The decrease in assets under management during the first quarter of 2007 was attributable to assets transferred in connection with the sale of the McDonald Investments branch network.
The growth in total assets under management was moderated by declines in the money market portfolio and Key’s securities lending business. When clients’ securities are lent to a borrower, the borrower must provide Key with cash collateral, which is invested during the term of the loan. The difference between the revenue generated from the investment and the cost of the collateral is shared with the lending client. This business, although profitable, generates a significantly lower rate of return (commensurate with the lower level of risk) than other types of assets under management.
Figure 11. Assets Under Management
                                         
    2007     2006  
in millions   Third     Second     First     Fourth     Third  
 
Assets under management by investment type:
                                       
Equity
  $ 44,465     $ 42,462     $ 40,065     $ 41,877     $ 39,831  
Securities lending
    22,056       22,595       21,608       21,146       22,699  
Fixed income
    11,372       11,187       11,420       11,242       11,311  
Money market
    8,861       8,069       8,260       9,402       9,298  
Hedge funds
    1,346       1,279       1,035       1,032       921  
 
Total
  $ 88,100     $ 85,592     $ 82,388     $ 84,699     $ 84,060  
 
                             
 
                                       
Proprietary mutual funds included in assets under management:
                                       
Money market
  $ 6,888     $ 6,280     $ 6,459     $ 7,579     $ 7,520  
Equity
    6,748       6,392       5,788       5,713       5,250  
Fixed income
    629       615       621       629       639  
 
Total
  $ 14,265     $ 13,287     $ 12,868     $ 13,921     $ 13,409  
 
                             
 
Service charges on deposit accounts. Service charges on deposit accounts were up from the prior year, due primarily to an increase in overdraft fees resulting from higher transaction volume, a rate increase instituted during the second quarter of 2007 and growth in the number of transaction accounts within Key’s Community Banking group.
Investment banking and capital markets income. As shown in Figure 12, the decreases in investment banking and capital markets income compared to the prior year were due primarily to less favorable results from other investments and from dealer trading and derivatives activities, reflecting extraordinary volatility in the fixed income markets during the third quarter of 2007. The loss recorded from other investments in the third quarter of 2007 was due largely to a $25 million decline in the fair values of two real estate-related investments held by the Private Equity unit within the Real Estate Capital line of business. The year-to date reduction in this revenue component was attributable to this decline and a $25 million gain from the initial public offering completed by the New York Stock Exchange during the first quarter of last year.
Figure 12. Investment Banking and Capital Markets Income
                                                                 
    Three months ended
September 30,
    Change     Nine months ended
September 30,
    Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
Investment banking income
  $ 22     $ 21     $ 1       4.8 %   $ 65     $ 69     $ (4 )     (5.8 )%
Income (loss) from other investments
    (22 )     5       (27 )     N/M       (11 )     37       (48 )     N/M  
Dealer trading and derivatives income (loss)
    (2 )     7       (9 )     N/M       18       23       (5 )     (21.7 )
Foreign exchange income
    11       11                   33       32       1       3.1  
 
Total investment banking and capital markets income
  $ 9     $ 44     $ (35 )     (79.5 )%   $ 105     $ 161     $ (56 )     (34.8 )%
 
                                                   
 
N/M = Not Meaningful
Operating lease income. The increase in operating lease income compared to the third quarter and first nine months of 2006 reflected a higher volume of activity in the Equipment Finance line of business. Depreciation expense related to the leased equipment is presented in Figure 13 as “operating lease expense.”

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Net gains from loan securitizations and sales. Key sells or securitizes loans to achieve desired interest rate and credit risk profiles, to improve the profitability of the overall loan portfolio or to diversify funding sources. During the third quarter of 2007, Key recorded $53 million of net losses from loan sales as well as changes in the estimated fair values of primarily commercial real estate loans held for sale. Recent volatility in the fixed income markets and the related housing correction caused a significant decrease in the value of these loans. The types of loans sold during 2007 and 2006 are presented in Figure 17 on page 57.
Net gains from principal investing. Principal investments consist of direct and indirect investments in predominantly privately-held companies. Key’s principal investing income is susceptible to volatility since most of it is derived from mezzanine debt and equity investments in small- to medium-sized businesses. These investments are carried on the balance sheet at fair value ($970 million at September 30, 2007, $830 million at December 31, 2006, and $843 million at September 30, 2006). The net gains presented in Figure 9 stem from changes in estimated fair values as well as gains resulting from the sales of principal investments.
Noninterest expense
Noninterest expense for the third quarter of 2007 was $753 million, down from $790 million for the third quarter of 2006. For the first nine months of the year, noninterest expense was $2.4 billion, essentially unchanged from the level reported one year ago.
As shown in Figure 13, personnel expense decreased by $35 million from the year-ago quarter, due to lower incentive compensation accruals. Nonpersonnel expense was down $2 million. Reductions in costs resulting from the sale of the McDonald Investments branch network accounted for a $46 million decline in total noninterest expense, including $27 million of the decrease in personnel expense.
For the year-to-date period, personnel expense decreased by $23 million from the same period last year, due to lower incentive compensation accruals stemming from the sale of the McDonald Investments branch network. Excluding a $42 million charge to litigation (included in “miscellaneous expense”) recorded in the second quarter of 2007, nonpersonnel expense was down $7 million. Reductions in professional fees, marketing expense and certain costs associated with the McDonald Investments branch network more than offset a substantial increase in operating lease expense. See Note 13 (“Contingent Liabilities and Guarantees”), which begins on page 28, for more information pertaining to the litigation charge.
Figure 13. Noninterest Expense
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
Personnel
  $ 383     $ 418     $ (35 )     (8.4 )%   $ 1,222     $ 1,245     $ (23 )     (1.8 )%
Net occupancy
    60       62       (2 )     (3.2 )     182       182              
Computer processing
    49       52       (3 )     (5.8 )     149       157       (8 )     (5.1 )
Operating lease expense
    58       48       10       20.8       165       134       31       23.1  
Professional fees
    27       28       (1 )     (3.6 )     79       101       (22 )     (21.8 )
Equipment
    22       26       (4 )     (15.4 )     71       78       (7 )     (9.0 )
Marketing
    21       32       (11 )     (34.4 )     60       70       (10 )     (14.3 )
Other expense:
                                                               
Postage and delivery
    11       13       (2 )     (15.4 )     34       38       (4 )     (10.5 )
Franchise and business taxes
    8       9       (1 )     (11.1 )     25       29       (4 )     (13.8 )
Telecommunications
    7       7                   21       21              
Provision for losses on lending-related commitments
    5             5       N/M       3             3       N/M  
Miscellaneous expense
    102       95       7       7.4       341       285       56       19.6  
 
Total other expense
    133       124       9       7.3       424       373       51       13.7  
 
Total noninterest expense
  $ 753     $ 790     $ (37 )     (4.7 )%   $ 2,352     $ 2,340     $ 12       .5 %
 
                                                   
 
                                                               
Average full-time equivalent employees a
    18,567       20,264       (1,697 )     (8.4 )%     19,081       19,974       (893 )     (4.5 )%
 
 
(a)   The number of average full-time equivalent employees has not been adjusted for discontinued operations.
N/M = Not Meaningful

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The following discussion explains the composition of certain elements of Key’s noninterest expense and the factors that caused those elements to change.
Personnel. As shown in Figure 14, personnel expense, the largest category of Key’s noninterest expense, decreased by $23 million, or 2%, from the first nine months of 2006. The decrease, which was attributable to the sale of the McDonald Investments branch network, was moderated by normal salary adjustments and higher stock-based compensation. The McDonald Investments branch network accounted for $20 million of Key’s personnel expense in the current year, compared to $88 million for the first nine months of 2006. For the third quarter of 2007, the average number of full-time equivalent employees was 18,567, compared to 18,888 for the second quarter of 2007 and 20,264 for the third quarter of 2006.
Figure 14. Personnel Expense
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2007     2006     Amount     Percent     2007     2006     Amount     Percent  
 
Salaries
  $ 240     $ 240                 $ 721     $ 703     $ 18       2.6 %
Incentive compensation
    55       93     $ (38 )     (40.9 )%     212       268       (56 )     (20.9 )
Employee benefits
    67       67                   222       222              
Stock-based compensation a
    17       15       2       13.3       57       47       10       21.3  
Severance
    4       3       1       33.3       10       5       5       100.0  
 
Total personnel expense
  $ 383     $ 418     $ (35 )     (8.4 )%   $ 1,222     $ 1,245     $ (23 )     (1.8 )%
 
                                                   
 
 
(a)   Excludes directors’ stock-based compensation of $.4 million and $.3 million for the three-month periods ended September 30, 2007 and 2006, respectively, and $1.7 million and $.9 million for the nine-month periods ended September 30, 2007 and 2006, respectively. Directors’ stock-based compensation is included in the “miscellaneous expense” component shown in Figure 13.
Operating lease expense. The increase in operating lease expense compared to the third quarter and first nine months of 2006 reflected a higher volume of activity in the Equipment Finance line of business. Income related to the rental of leased equipment is presented in Figure 9 as “operating lease income.”
Professional fees. The decrease in professional fees for the year-to-date period was due in part to a reduction in costs associated with Key’s efforts to strengthen compliance controls, for which substantial investment has already been made.
Marketing expense. The decreases in marketing expense for both the quarterly and year-to-date periods were attributable to additional costs incurred during 2006 to promote Key’s free checking products.
Income taxes
The provision for income taxes from continuing operations was $86 million for the third quarter of 2007, compared to $118 million for the comparable period in 2006. The effective tax rate, which is the provision for income taxes from continuing operations as a percentage of income from continuing operations before income taxes, was 27.7% for the third quarter of 2007, compared to 27.9% for the year-ago quarter. For the first nine months of 2007, the provision for income taxes was $363 million, compared to $353 million for the first nine months of 2006. The effective tax rates for these periods were 28.3% and 28.6%, respectively.
The effective tax rates for both the current and prior year are substantially below Key’s combined federal and state tax rate of 37.5%, primarily because Key generates income from investments in tax-advantaged assets such as corporate-owned life insurance, earns credits associated with investments in low-income housing projects and records tax deductions associated with dividends paid on Key common shares held in Key’s 401(k) savings plan. In addition, a lower tax rate is applied to portions of the equipment lease portfolio that are managed by a foreign subsidiary in a lower tax jurisdiction. Since Key intends to permanently reinvest the earnings of this foreign subsidiary overseas, no deferred income taxes are recorded on those earnings in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes.”

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Financial Condition
Loans and loans held for sale
At September 30, 2007, total loans outstanding were $69.0 billion, compared to $65.8 billion at December 31, 2006, and $65.6 billion at September 30, 2006. The composition of Key’s loan portfolio at each of these dates is presented in Note 6 (“Loans and Loans Held for Sale”), which begins on page 20. The increase in Key’s loan portfolio over the past twelve months was primarily attributable to strong growth in the commercial mortgage, and commercial, financial and agricultural portfolios.
Commercial loan portfolio. Commercial loans outstanding grew by $3.0 billion, or 6%, from one year ago, largely due to a higher volume of originations in the commercial mortgage, and commercial, financial and agricultural portfolios. Greater reliance by borrowers on commercial lines of credit in a volatile capital markets environment also contributed to the increase. The overall growth in the commercial loan portfolio was geographically broad-based and spread among a number of industry sectors.
Commercial real estate loans for both owner- and nonowner-occupied properties constitute one of the largest segments of Key’s commercial loan portfolio. At September 30, 2007, Key’s commercial real estate portfolio included mortgage loans of $9.3 billion and construction loans of $8.2 billion. The average mortgage loan originated during the first nine months of 2007 was $2 million, and the largest mortgage loan at September 30, 2007, had a balance of $83 million. At September 30, 2007, the average construction loan commitment was $6 million. The largest construction loan commitment was $95 million, of which the entire amount was outstanding and on nonperforming status.
Key’s commercial real estate lending business is conducted through two primary sources: a thirteen-state banking franchise and Real Estate Capital, a national line of business that cultivates relationships both within and beyond the branch system. Real Estate Capital deals exclusively with nonowner-occupied properties (generally properties in which at least 50% of the debt service is provided by rental income from nonaffiliated third parties) and accounted for approximately 63% of Key’s total average commercial real estate loans during the third quarter of 2007. Key’s commercial real estate business generally focuses on larger real estate developers and, as shown in Figure 15, is diversified by both industry type and geographic location of the underlying collateral.
Figure 15. Commercial Real Estate Loans
                                                                 
September 30, 2007   Geographic Region             Percent of  
dollars in millions   Northeast     Southeast     Southwest     Midwest     Central     West     Total     Total  
 
Nonowner-occupied:
                                                               
Residential properties
  $ 234     $ 1,093     $ 309     $ 185     $ 477     $ 1,445     $ 3,743       21.4 %
Multi-family properties
    330       293       243       263       471       449       2,049       11.7  
Retail properties
    167       652       175       389       338       255       1,976       11.3  
Land and development
    60       247       207       113       227       202       1,056       6.1  
Office buildings
    165       244       91       194       138       309       1,141       6.5  
Warehouses
    79       161       12       81       80       176       589       3.4  
Health facilities
    142       146       14       125       56       123       606       3.5  
Manufacturing facilities
    4       57       22       23             18       124       .7  
Hotels/Motels
    1       39             15       50       52       157       .9  
Other
    179       22       2       211       92       199       705       4.0  
 
 
    1,361       2,954       1,075       1,599       1,929       3,228       12,146       69.5  
Owner-occupied
    1,044       204       109       2,006       483       1,494       5,340       30.5  
 
Total
  $ 2,405     $ 3,158     $ 1,184     $ 3,605     $ 2,412     $ 4,722     $ 17,486       100.0 %
 
                                               
 
Nonowner-occupied:
                                                               
Nonperforming loans
  $ 9     $ 106           $ 25     $ 7     $ 81     $ 228       N/M  
Accruing loans past due 90 days or more
                      4             32       36       N/M  
Accruing loans past due 30 through 89 days
    29       20     $ 16       14       1       33       113       N/M  
 
     
Northeast –      
  Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont
Southeast –
  Alabama, Delaware, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, South Carolina, Tennessee, Virginia, Washington D.C. and West Virginia
Southwest –
  Arizona, Nevada and New Mexico
Midwest –
  Idaho, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota and Wisconsin
Central –
  Arkansas, Colorado, Oklahoma, Texas and Utah
West –
  Alaska, California, Hawaii, Montana, Oregon, Washington and Wyoming
N/M = Not Meaningful

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During the third quarter of 2007, nonperforming loans related to Key’s nonowner-occupied properties rose by $200 million, due primarily to deteriorating market conditions in the residential properties segment of Key’s commercial real estate construction portfolio. The majority of the increase in this segment relates to loans outstanding in Florida and southern California.
Management believes Key has both the scale and array of products to compete on a world-wide basis in the specialty of equipment lease financing. These financing arrangements are conducted through the Equipment Finance line of business. Commercial lease financing receivables increased by $449 million, or 5%, over the past twelve months.
Consumer loan portfolio. Consumer loans outstanding increased by $415 million, or 2%, from one year ago. The growth was largely attributable to new originations in Key’s indirect marine loan portfolio, offset in part by a decline in Key’s consumer – direct loan portfolio. The growth of the consumer loan portfolio also was moderated by a general slowdown in the level of home equity loan originations over the past year. Excluding loan sales and acquisitions, consumer loans would have increased by $486 million, or 3%, during the past twelve months.
The home equity portfolio is by far the largest segment of Key’s consumer loan portfolio. This portfolio is derived primarily from the Regional Banking line of business (responsible for 89% of home equity loans at September 30, 2007); the remainder originated from the Home Equity Services unit within Key’s Consumer Finance line of business, which works with home improvement contractors to provide home equity and home improvement financing solutions.
Figure 16 summarizes Key’s home equity loan portfolio by source at the end of each of the last five quarters, as well as certain asset quality statistics and yields on the portfolio as a whole.
Figure 16. Home Equity Loans
                                         
    2007     2006  
dollars in millions   Third     Second     First     Fourth     Third  
 
SOURCES OF LOANS OUTSTANDING
                                       
Regional Banking
  $ 9,674     $ 9,736     $ 9,623     $ 9,805     $ 9,990  
Home Equity Services unit
    1,230       1,143       1,046       1,021       998  
 
Total
  $ 10,904     $ 10,879     $ 10,669     $ 10,826     $ 10,988  
 
                             
 
Nonperforming loans at period end
  $ 61     $ 55     $ 52     $ 50     $ 46  
Net loan charge-offs for the period
    8       6       7       6       4  
Yield for the period a
    7.22 %     7.22 %     7.22 %     7.22 %     7.19 %
 
(a)   From continuing operations.
Loans held for sale. As shown in Note 6, Key’s loans held for sale were $4.8 billion at September 30, 2007, compared to $3.6 billion at December 31, 2006, and $7.2 billion at September 30, 2006. The decline over the past twelve months was due primarily to the November 2006 sale of the $2.5 billion nonprime mortgage loan portfolio held by the Champion Mortgage finance business, which was transferred to the held-for-sale portfolio during the third quarter of 2006 in anticipation of the sale.
At September 30, 2007, Key’s loans held for sale included $2.9 billion of education loans and $1.6 billion of commercial mortgage loans. In the absence of quoted market prices, management uses valuation models to measure the fair value of these loans and adjusts the amount recorded on the balance sheet if fair value falls below recorded cost. The models are based on assumptions related to prepayment speeds, default rates, funding cost and discount rates. In light of recent volatility in the financial markets, management has reviewed Key’s assumptions and determined they are representative of current market conditions. As a result, no significant adjustments to the assumptions were required during the third quarter of 2007. During the third quarter, net losses pertaining to Key’s loans held for sale totaled $74 million, of which $37 million were unrealized. These losses are recorded in “net gains (losses) from loan securitizations and sales” on the income statement. Key has not been significantly impacted by market volatility in the nonprime mortgage lending industry due to the sale of the Champion Mortgage finance business discussed above.

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Sales and securitizations. Key continues to use alternative funding sources like loan sales and securitizations to support its loan origination capabilities. In addition, several acquisitions completed over the past several years have improved Key’s ability to originate and sell new loans, and to securitize and service loans generated by others, especially in the area of commercial real estate.
During the past twelve months, Key sold $3.9 billion of commercial mortgage loans ($238 million through a securitization), $2.7 billion of home equity loans, $1.2 billion of education loans ($963 million through a securitization), $445 million of residential real estate loans, $299 million of commercial loans and leases, and $90 million of consumer – direct loans. Most of these sales came from the held-for-sale portfolio.
Among the factors Key considers in determining whether to sell or securitize certain loans or portfolios are:
     
¨
  whether particular lending businesses meet established performance standards or fit with Key’s relationship banking strategy;
 
   
¨
  Key’s asset/liability management needs;
 
   
¨
  whether the characteristics of a specific loan portfolio make it conducive to securitization;
 
   
¨
  the cost of alternative funding sources;
 
   
¨
  the level of credit risk;
 
   
¨
  capital requirements; and
 
   
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  market conditions and pricing.
Key typically completes an annual securitization and sale of education loans during the second half of the year. In light of recent volatility in the financial markets, this securitization has not yet occurred in 2007 and may be delayed until the first half of 2008.
Figure 17 summarizes Key’s loan sales (including securitizations) for the first nine months of 2007 and all of 2006.
Figure 17. Loans Sold (Including Loans Held for Sale)
                                                                 
            Commercial     Commercial     Residential     Home     Consumer              
in millions   Commercial     Real Estate     Lease Financing     Real Estate     Equity     — Direct     Education     Total  
 
2007
                                                               
Third quarter
  $ 17     $ 1,059     $ 35     $ 127                 $ 44     $ 1,282  
Second quarter
    36       1,079       98       118                   118       1,449  
First quarter
    15       688       5       100     $ 233     $ 90       61       1,192  
 
Total
  $ 68     $ 2,826     $ 138     $ 345     $ 233     $ 90     $ 223     $ 3,923  
 
                                               
 
2006
                                                               
Fourth quarter
  $ 80     $ 1,070     $ 13     $ 100     $ 2,474           $ 983     $ 4,720  
Third quarter
    37       679       16       109       2             143       986  
Second quarter
    64       483             97                   110       754  
First quarter
    40       406       105       54                   172       777  
 
Total
  $ 221     $ 2,638     $ 134     $ 360     $ 2,476           $ 1,408     $ 7,237  
 
                                               
 
Figure 18 shows loans that are either administered or serviced by Key, but not recorded on the balance sheet. Included are loans that have been both securitized and sold, or simply sold outright.
Figure 18. Loans Administered or Serviced
                                         
    September 30,     June 30,     March 31,     December 31,     September 30,  
in millions   2007     2007     2007     2006     2006  
 
Commercial real estate loans a
  $ 134,510     $ 121,384     $ 108,303     $ 93,611     $ 81,873  
Education loans
    4,984       5,118       5,251       5,475       4,640  
Home equity loans b
                      2,360       4  
Commercial lease financing
    657       529       458       479       479  
Commercial loans
    228       242       243       268       252  
 
Total
  $ 140,379     $ 127,273     $ 114,255     $ 102,193     $ 87,248  
 
                             
 
(a)   Key acquired the servicing for commercial mortgage loan portfolios with an aggregate principal balance of $21.1 billion for the third quarter 2007, $6.4 billion for the second quarter 2007, $12.7 billion for the first quarter 2007 and $9.0 billion for the fourth quarter 2006.
 
(b)   In November 2006, Key sold the $2.5 billion nonprime mortgage loan portfolio held by the Champion Mortgage finance business but continued to provide servicing through various dates in March 2007.

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In the event of default by a borrower, Key is subject to recourse with respect to $579 million of the $140.4 billion of loans administered or serviced at September 30, 2007. Additional information about this recourse arrangement is included in Note 13 (“Contingent Liabilities and Guarantees”) under the heading “Recourse agreement with Federal National Mortgage Association” on page 29.
Key derives income from several sources when loans are securitized or sold, but Key retains the right to administer or service them. Key earns noninterest income (recorded as “other income”) from fees for servicing or administering loans. In addition, Key earns interest income from securitized assets retained and from lending funds generated by escrow deposits collected in connection with the servicing of commercial real estate loans. These deposits have contributed to the growth in Key’s average noninterest-bearing deposits over the past twelve months, thereby moderating Key’s overall cost of funds.
Securities
At September 30, 2007, the securities portfolio totaled $10.5 billion, including $7.9 billion of securities available for sale, $36 million of investment securities, $1.1 billion of trading account securities included in “short-term investments” on the balance sheet and $1.5 billion of other investments (primarily principal investments). In comparison, the total portfolio at December 31, 2006, was $10.1 billion and included $7.8 billion of securities available for sale, $41 million of investment securities, $912 million of trading account securities and $1.4 billion of other investments. At September 30, 2006, the securities portfolio totaled $9.7 billion and included $7.4 billion of securities available for sale, $41 million of investment securities, $817 million of trading account securities and $1.4 billion of other investments.
Securities available for sale. The majority of Key’s securities available-for-sale portfolio consists of collateralized mortgage obligations (“CMO”). A CMO is a debt security that is secured by a pool of mortgages or mortgage-backed securities. Key’s CMOs generate interest income and serve as collateral to support certain pledging agreements. At September 30, 2007, Key had $7.5 billion invested in CMOs and other mortgage-backed securities, compared to $7.3 billion at December 31, 2006, and $6.9 billion at September 30, 2006. Substantially all of Key’s mortgage-backed securities are issued or backed by federal agencies.
Management periodically evaluates Key’s securities available-for-sale portfolio in light of established asset/liability management objectives, and changing market conditions which could affect the profitability of the portfolio, as well as the level of interest rate risk to which Key is exposed. As a result of these evaluations, management may take steps to improve Key’s overall balance sheet positioning.
In March 2007, management completed a comprehensive evaluation of the securities available-for-sale portfolio and determined that a repositioning of the portfolio was appropriate to enhance future financial performance, particularly in the event of a decline in interest rates. As a result, Key sold $2.4 billion of shorter-maturity, agency-issued CMOs and reinvested the proceeds in agency-issued securities with higher yields and longer expected average maturities. The weighted-average yield of Key’s available-for-sale portfolio increased from 4.78% at December 31, 2006, to 5.25% at September 30, 2007, and the weighted-average maturity of the portfolio increased from 2.6 years at December 31, 2006, to 3.5 years at September 30, 2007. The repositioning also served to reduce Key’s exposure to prepayment risk in a declining interest rate scenario. This was accomplished by replacing the CMOs sold with those that have underlying mortgage loans with shorter maturities and lower coupon rates. Key maintains a modest liability-sensitive exposure to near-term changes in interest rates. Neither funding nor capital levels were affected materially by this portfolio repositioning.
As a result of the sale, Key recorded a loss of $49 million ($31 million after tax, $.08 per diluted common share) during the first quarter of 2007. This loss was previously recorded in “net unrealized losses on securities available for sale” in the accumulated other comprehensive loss component of shareholders’ equity.

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In addition to changing market conditions, the size and composition of Key’s securities available-for-sale portfolio could vary with Key’s needs for liquidity and the extent to which Key is required (or elects) to hold these assets as collateral to secure public funds and trust deposits. Although debt securities are generally used for this purpose, other assets, such as securities purchased under resale agreements, may be used temporarily when they provide more favorable yields or risk profiles.
For most of Key’s mortgage-backed securities, management employs an outside bond pricing service to assist in measuring the fair value at which they should be recorded on the balance sheet. In performing the valuations, the pricing service relies on models which are based on a number of economic observations, including quoted market prices and interest rate spreads on relevant benchmark securities, along with certain economic assumptions. For certain mortgage-backed securities, the pricing service is unable to provide pricing. In those instances, management uses a purchased pricing model and inputs data similar to that described above. All of the mortgage-backed security valuations are reviewed by Key’s management for reasonableness to ensure they are representative of current market conditions. During the third quarter of 2007, net gains from Key’s mortgage-backed securities totaled $120 million, reflecting the decline in benchmark Treasury yields, offset in part by the widening of interest rate spreads on these securities. Substantially all of the net gains were unrealized and, therefore, recorded in the “accumulated other comprehensive loss” component of shareholders’ equity. Realized gains and losses, which are recorded in “net securities gains (losses)” on the income statement, were not significant.
Figure 19 shows the composition, yields and remaining maturities of Key’s securities available for sale. For more information about Key’s securities, including gross unrealized gains and losses by type of security, see Note 5 (“Securities”), which begins on page 18.
Figure 19. Securities Available for Sale
 
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