Form 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, 2008
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 LOGO)     
(Exact name of registrant as specified in its charter)
Ohio   34-6542451
     
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ    Accelerated filer o    Non-accelerated filer   o   Smaller reporting company o 
    (Do not check if a smaller reporting company)
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   495,007,818 Shares
     
(Title of class)   (Outstanding at October 31, 2008)
 
 

 


 

KEYCORP
TABLE OF CONTENTS
         
PART I. FINANCIAL INFORMATION
         
        Page Number
Item 1.      
   
 
   
      3
   
 
   
      4
   
 
   
      5
   
 
   
      6
   
 
   
      7
   
 
   
      39
   
 
   
Item 2.     40
   
 
   
Item 3.     94
   
 
   
Item 4.     94
   
 
   
PART II. OTHER INFORMATION
   
 
   
Item 1.     95
   
 
   
Item 1A.     95
   
 
   
Item 2.     97
   
 
   
Item 6.     97
   
 
   
      98
   
 
   
   
Exhibits
  99
 EX-15
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2

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Table of Contents

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
                         
    September 30,     December 31,     September 30,  
dollars in millions   2008     2007     2007  
    (Unaudited)             (Unaudited)  
ASSETS
                       
Cash and due from banks
  $ 1,937     $ 1,814     $ 2,016  
Short-term investments
    653       516       528  
Trading account assets
    1,449       1,056       1,060  
Securities available for sale
    8,391       7,860       7,915  
Held-to-maturity securities (fair value: $28, $28 and $36)
    28       28       36  
Other investments
    1,556       1,538       1,509  
Loans, net of unearned income of $2,497, $2,202 and $2,227
    76,705       70,823       68,999  
Less: Allowance for loan losses
    1,554       1,200       955  
 
Net loans
    75,151       69,623       68,044  
Loans held for sale
    1,475       4,736       4,791  
Premises and equipment
    801       681       631  
Operating lease assets
    1,030       1,128       1,135  
Goodwill
    1,595       1,252       1,202  
Other intangible assets
    135       123       105  
Corporate-owned life insurance
    2,940       2,872       2,845  
Derivative assets
    951       879       539  
Accrued income and other assets
    3,198       4,122       3,781  
 
Total assets
  $ 101,290     $ 98,228     $ 96,137  
 
                 
 
                       
LIABILITIES
                       
Deposits in domestic offices:
                       
NOW and money market deposit accounts
  $ 25,789     $ 27,635     $ 24,198  
Savings deposits
    1,731       1,513       1,544  
Certificates of deposit ($100,000 or more)
    10,316       6,982       6,672  
Other time deposits
    13,929       11,615       11,403  
 
Total interest-bearing
    51,765       47,745       43,817  
Noninterest-bearing
    11,122       11,028       14,003  
Deposits in foreign office ¾ interest-bearing
    1,791       4,326       5,894  
 
Total deposits
    64,678       63,099       63,714  
Federal funds purchased and securities sold under repurchase agreements
    1,799       3,927       5,398  
Bank notes and other short-term borrowings
    5,352       5,861       2,429  
Derivative liabilities
    589       252       218  
Accrued expense and other liabilities
    4,624       5,386       5,009  
Long-term debt
    15,597       11,957       11,549  
 
Total liabilities
    92,639       90,482       88,317  
 
                       
SHAREHOLDERS’ EQUITY
                       
Preferred stock, $1 par value, authorized 25,000,000 shares:
7.750% Noncumulative Perpetual Convertible Preferred Stock, Series A, $100
liquidation preference; authorized 7,475,000 shares; issued 6,575,000 shares
    658              
Common shares, $1 par value; authorized 1,400,000,000 shares;
issued 584,061,120, 491,888,780 and 491,888,780 shares
    584       492       492  
Capital surplus
    2,552       1,623       1,617  
Retained earnings
    7,320       8,522       8,788  
Treasury stock, at cost (89,295,628, 103,095,907 and 103,180,446 shares)
    (2,616 )     (3,021 )     (3,023 )
Accumulated other comprehensive income (loss)
    153       130       (54 )
 
Total shareholders’ equity
    8,651       7,746       7,820  
 
Total liabilities and shareholders’ equity
  $ 101,290     $ 98,228     $ 96,137  
 
                 
 
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   2008     2007     2008     2007  
 
INTEREST INCOME
                               
Loans
  $ 1,066     $ 1,209     $ 2,906     $ 3,546  
Loans held for sale
    21       91       128       248  
Securities available for sale
    110       106       330       312  
Held-to-maturity securities
    1             2       1  
Trading account assets
    16       11       39       26  
Short-term investments
    6       5       23       24  
Other investments
    12       12       38       40  
 
Total interest income
    1,232       1,434       3,466       4,197  
 
                               
INTEREST EXPENSE
                               
Deposits
    347       482       1,122       1,362  
Federal funds purchased and securities sold under repurchase agreements
    10       55       53       163  
Bank notes and other short-term borrowings
    34       30       100       59  
Long-term debt
    142       173       421       554  
 
Total interest expense
    533       740       1,696       2,138  
 
 
                               
NET INTEREST INCOME
    699       694       1,770       2,059  
Provision for loan losses
    407       69       1,241       166  
 
Net interest income after provision for loan losses
    292       625       529       1,893  
 
                               
NONINTEREST INCOME
                               
Trust and investment services income
    133       119       400       359  
Service charges on deposit accounts
    94       88       275       247  
Investment banking and capital markets (loss) income
    (31 )     9       57       105  
Operating lease income
    69       70       206       200  
Letter of credit and loan fees
    53       51       141       134  
Corporate-owned life insurance income
    28       27       84       84  
Electronic banking fees
    27       25       78       74  
Net losses from loan securitizations and sales
    (30 )     (53 )     (98 )     (11 )
Net securities gains (losses)
    1       4       3       (41 )
Net (losses) gains from principal investing
    (24 )     9       (29 )     128  
Gain from redemption of Visa Inc. shares
                165        
Gain from sale of McDonald Investments branch network
                      171  
Other income
    68       89       189       291  
 
Total noninterest income
    388       438       1,471       1,741  
 
                               
NONINTEREST EXPENSE
                               
Personnel
    381       383       1,194       1,222  
Net occupancy
    65       60       193       182  
Computer processing
    46       49       136       149  
Operating lease expense
    56       58       169       165  
Professional fees
    35       27       91       79  
Equipment
    23       22       70       71  
Marketing
    27       21       62       60  
Other expense
    129       133       360       424  
 
Total noninterest expense
    762       753       2,275       2,352  
 
                               
(LOSS) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
    (82 )     310       (275 )     1,282  
Income taxes
    (46 )     86       669       363  
 
(LOSS) INCOME FROM CONTINUING OPERATIONS
    (36 )     224       (944 )     919  
Loss from discontinued operations, net of taxes of ($8) and ($15), respectively (see Note 3)
          (14 )           (25 )
 
NET (LOSS) INCOME
  $ (36 )   $ 210     $ (944 )   $ 894  
 
                       
 
                               
Net (loss) income applicable to common shares
  $ (48 )   $ 210     $ (956 )   $ 894  
 
                               
Per common share:
                               
(Loss) income from continuing operations
  $ (.10 )   $ .58     $ (2.19 )   $ 2.34  
Net (loss) income
    (.10 )     .54       (2.19 )     2.28  
Per common share — assuming dilution:
                               
(Loss) income from continuing operations
  $ (.10 )   $ .57     $ (2.19 )   $ 2.31  
Net (loss) income
    (.10 )     .54       (2.19 )     2.25  
Cash dividends declared per common share
  $ .1875     $ .365     $ .9375     $ 1.095  
Weighted-average common shares outstanding (000)
    491,179       389,319       435,846       393,048  
Weighted-average common shares and potential common shares outstanding (000)
    491,179       393,164       435,846       397,816  
 
See Notes to Consolidated Financial Statements (Unaudited).

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Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
                                                                         
                                                            Accumulated        
                                                    Treasury     Other        
    Preferred Stock     Common Shares     Preferred     Common     Capital     Retained     Stock,     Comprehensive     Comprehensive  
dollars in millions, except per share amounts   Outstanding (000)     Outstanding (000)     Stock     Shares     Surplus     Earnings     at Cost     Income (Loss)     Income (Loss)  
 
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)
                                            (52 )                        
Cumulative effect of adopting FIN 48,
net of income taxes of ($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 $31 a
                                                            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 )                
Common shares reissued for stock options and other employee
benefit plans
            5,555                       3               156                  
Common shares repurchased
            (16,000 )                                     (595 )        
         
BALANCE AT SEPTEMBER 30, 2007
          388,708           $ 492     $ 1,617     $ 8,788     $ (3,023 )   $ (54 )        
 
                                                       
         
BALANCE AT DECEMBER 31, 2007
          388,793           $ 492     $ 1,623     $ 8,522     $ (3,021 )   $ 130  
Net loss
                                            (944 )                   $ (944 )
Other comprehensive loss:
                                                                       
Net unrealized gains on securities available for sale, net of income
taxes of $40 a
                                                            64       64  
Net unrealized losses on derivative financial instruments, net of income taxes of $(3)
                                                            (24 )     (24 )
Net unrealized losses on common investments held in employee welfare benefits trust, net of income taxes
                                                            (1 )     (1 )
Foreign currency translation adjustments
                                                            (22 )     (22 )
Net pension and postretirement benefit costs, net of income taxes
                                                            6       6  
 
                                                                     
Total comprehensive loss
                                                                  $ (921 )
 
                                                                     
Deferred compensation
                                    6       (3 )                
Cash dividends declared on common shares ($.5625 per share)
                                            (243 )                
Cash dividends declared on preferred shares ($1.873 per share)
                                            (12 )                        
Preferred stock issued
    6,575             $ 658               (20 )                        
Common shares issued
            92,172               92       967                                  
Common shares reissued:
                                                               
Acquisition of U.S.B. Holding Co., Inc.
            9,895                       58               290                  
Stock options and other employee
benefit plans
            3,905                       (82 )             115          
         
BALANCE AT SEPTEMBER 30, 2008
    6,575       494,765     $ 658     $ 584     $ 2,552     $ 7,320     $ (2,616 )   $ 153          
 
                                                       
         
(a)   Net of reclassification adjustments.
 
See Notes to Consolidated Financial Statements (Unaudited).

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Table of Contents

Consolidated Statements of Cash Flows (Unaudited)
                 
    Nine months ended  
    September 30,  
in millions   2008     2007  
 
OPERATING ACTIVITIES
               
Net (loss) income
  $ (944 )   $ 894  
Adjustments to reconcile net (loss) income to net cash used in operating activities:
               
Provision for loan losses
    1,241       166  
Depreciation and amortization expense
    327       316  
Write-off of goodwill
    4        
Honsador litigation reserve
    (23 )     42  
Net securities (gains) losses
    (3 )     41  
Liability to Visa
    (64 )      
Gain from redemption of Visa Inc. shares
    (165 )      
Gain from sale of McDonald Investments branch network
          (171 )
Gain related to MasterCard Incorporated shares
          (67 )
Gain from settlement of automobile residual value insurance litigation
          (26 )
Net losses (gains) from principal investing
    29       (128 )
Net losses from loan securitizations and sales
    98       11  
Loss from sale of discontinued operations
          2  
Proceeds from settlement of automobile residual value insurance litigation
          279  
Deferred income taxes
    (245 )     (53 )
Net decrease (increase) in loans held for sale from continuing operations
    378       (1,154 )
Net increase in trading account assets
    (393 )     (148 )
Other operating activities, net
    504       (603 )
 
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
    744       (599 )
INVESTING ACTIVITIES
               
Proceeds from redemption of Visa Inc. shares
    165        
Proceeds from sale of McDonald Investments branch network, net of retention payments
          199  
Proceeds from sale of MasterCard Incorporated shares
          67  
Cash used in acquisitions, net of cash acquired
    (184 )      
Net increase in short-term investments
    (70 )     (168 )
Purchases of securities available for sale
    (1,191 )     (4,333 )
Proceeds from sales of securities available for sale
    877       2,506  
Proceeds from prepayments and maturities of securities available for sale
    1,124       1,788  
Purchases of held-to-maturity securities
    (6 )      
Proceeds from prepayments and maturities of held-to-maturity securities
    6       5  
Purchases of other investments
    (391 )     (500 )
Proceeds from sales of other investments
    148       275  
Proceeds from prepayments and maturities of other investments
    124       138  
Net increase in loans, excluding acquisitions, sales and transfers
    (2,798 )     (3,723 )
Purchases of loans
    (18 )     (61 )
Proceeds from loan securitizations and sales
    280       306  
Purchases of premises and equipment
    (114 )     (123 )
Proceeds from sales of premises and equipment
    8       9  
Proceeds from sales of other real estate owned
    16       61  
 
NET CASH USED IN INVESTING ACTIVITIES
    (2,024 )     (3,554 )
FINANCING ACTIVITIES
               
Net (decrease) increase in deposits
    (227 )     4,594  
Net (decrease) increase in short-term borrowings
    (3,427 )     3,306  
Net proceeds from issuance of long-term debt
    4,957       393  
Payments on long-term debt
    (1,189 )     (3,490 )
Purchases of treasury shares
          (595 )
Net proceeds from issuance of common shares and preferred stock
    1,688        
Net proceeds from reissuance of common shares
    6       111  
Tax benefits (under) over recognized compensation cost for stock-based awards
    (2 )     13  
Cash dividends paid
    (403 )     (427 )
 
NET CASH PROVIDED BY FINANCING ACTIVITIES
    1,403       3,905  
 
NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS
    123       (248 )
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD
    1,814       2,264  
 
CASH AND DUE FROM BANKS AT END OF PERIOD
  $ 1,937     $ 2,016  
 
           
 
Additional disclosures relative to cash flows:
               
Interest paid
  $ 1,683     $ 2,211  
Income taxes paid
    329       276  
Noncash items:
               
Assets acquired
  $ 2,810        
Liabilities assumed
    2,648        
Loans transferred to portfolio from held for sale
    3,342        
Loans transferred to held for sale from portfolio
    459        
Loans transferred to other real estate owned
    67     $ 31  
 
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 holding company.
 
¨   KeyBank refers to KeyCorp’s subsidiary bank, KeyBank National Association.
 
¨   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 23 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 fair value.
Qualifying special purpose entities, 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 2007 Annual Report to Shareholders under the heading “Loan Securitizations” on page 67.
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 2007 Annual Report to Shareholders.
Goodwill and Other Intangible Assets
Under SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill and certain intangible assets are subject to impairment testing, which must be conducted at least annually. Key typically performs this required testing in the fourth quarter of each year, or more frequently if events or circumstances indicate possible impairment. Key’s reporting units for purposes of this testing are its major business segments: Community Banking and National Banking.

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The first step in impairment testing is to determine the fair value of each reporting unit. If the carrying amount of a reporting unit exceeds its fair value, goodwill impairment may be indicated. In such a case, Key would estimate a purchase price for the reporting unit (representing the unit’s fair value) and then compare that hypothetical purchase price to the fair value of the unit’s net assets (excluding goodwill). Any excess of the estimated purchase price over the fair value of the reporting unit’s net assets represents the implied fair value of goodwill. An impairment loss would be recognized as a charge to earnings to the extent the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of goodwill.
Key’s results for the first nine months of 2008 were adversely affected by after-tax charges of $1.011 billion recorded during the second quarter as a result of a previously announced adverse federal court decision on the tax treatment of a Service Contract Lease transaction, and a substantial increase to the provision for loan losses. Additionally, 2008 results have been adversely affected by severe market disruptions that continued through the third quarter. As a result of these factors, management tested Key’s goodwill for impairment as of June 30, 2008, and determined that no impairment existed at that date. Based on a September 30, 2008, review of the fair value of Key’s reporting units, management determined that no further impairment testing was required as of that date. As in prior years, management will perform Key’s annual impairment testing of goodwill as of October 1, 2008.
Derivatives
Effective January 1, 2008, Key adopted the accounting guidance in FASB Staff Position FIN 39-1, “Amendment of FASB Interpretation 39,” and as a result, also adopted the provisions of Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts.” As a result of adopting this guidance, Key changed its accounting policy pertaining to the recognition of derivative assets and liabilities to take into account the impact of master netting agreements that allow Key to settle all derivative contracts held with a single counterparty on a net basis and to offset the net derivative position with the related cash collateral. Additional information regarding Key’s adoption of this accounting guidance is provided in Note 14 (“Derivatives and Hedging Activities”), which begins on page 32, and under the heading “Accounting Pronouncements Adopted in 2008” on page 9 of this note.
Fair Value Measurements
Effective January 1, 2008, Key adopted SFAS No. 157, “Fair Value Measurements,” for all applicable financial and nonfinancial assets and liabilities. This accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 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.
As defined in SFAS No. 157, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants. It represents an exit price at the measurement date. Market participants are buyers and sellers, who are independent, knowledgeable, and willing and able to transact in the principal (or most advantageous) market for the asset or liability being measured. Current market conditions, including imbalances between supply and demand, are considered in determining fair value.
Key values its assets and liabilities in the principal market where it sells the particular asset or transfers the liability with the greatest volume and level of activity. In the absence of a principal market, the valuation is based on the most advantageous market for the asset or liability
(i.e., the market where the asset could be sold or the liability transferred at a price that maximizes the amount to be received for the asset or minimizes the amount to be paid to transfer the liability).
In measuring the fair value of an asset, Key assumes the highest and best use of the asset by a market participant to maximize the value of the asset, and does not consider the intended use of the asset.
When measuring the fair value of a liability, Key assumes that the nonperformance risk associated with the liability is the same before and after the transfer. Nonperformance risk is the risk that an obligation will not be satisfied and encompasses not only Key’s own credit risk (i.e., the risk that Key will fail to meet its obligation), but also other risks such as settlement risk. Key considers the effect of its own credit risk on the fair value for any period in which fair value is measured.

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There are three acceptable valuation techniques that can be used to measure fair value: the market approach, the income approach and the cost approach. Selection of the appropriate technique for valuing a particular asset or liability takes into consideration the exit market, the nature of the asset or liability being valued, and how a market participant would value the same asset or liability. Ultimately, determination of the appropriate valuation method requires significant judgment, and sufficient knowledge and expertise are required to apply the valuation techniques.
Valuation inputs refer to the assumptions market participants would use in pricing a given asset or liability using one of the three valuation techniques. Inputs can be observable or unobservable. Observable inputs are those assumptions which market participants would use in pricing the particular asset or liability. These inputs are based on market data and are obtained from a source independent of Key.
Unobservable inputs are assumptions based on Key’s own information or estimate of assumptions used by market participants in pricing the asset or liability. Unobservable inputs are based on the best and most current information available on the measurement date.
All inputs, whether observable or unobservable, are ranked in accordance with a prescribed fair value hierarchy which gives the highest ranking to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest ranking to unobservable inputs
(Level 3). Fair values for assets or liabilities classified as Level 2 are based on one or a combination of the following factors: (i) quoted prices for similar assets; (ii) observable inputs for the asset or liability, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. Key considers an input to be significant if it drives 10% or more of the total fair value of a particular asset or liability.
Assets and liabilities are considered to be fair valued on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly or quarterly). Recurring valuation occurs at a minimum on the measurement date.
Assets and liabilities are considered to be fair valued on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the balance sheet. Generally, nonrecurring valuation is the result of the application of other accounting pronouncements which require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value.
The fair value of assets or liabilities transferred in or out of Level 3 is measured on the transfer date, with any additional changes in fair value subsequent to the transfer considered to be realized or unrealized gains or losses.
Additional information regarding fair value measurements and Key’s adoption of SFAS No. 157 is provided in Note 15 (“Fair Value Measurements”), which begins on page 35, and under the heading “Accounting Pronouncements Adopted in 2008” below.
Accounting Pronouncements Adopted in 2008
Fair value measurements. In September 2006, the FASB issued SFAS No. 157, 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 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008, for Key). In February 2008, the FASB issued Staff Position FAS 157-2, which delayed the effective date of SFAS No. 157 for all nonfinancial assets and liabilities, except those recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008. However, early adoption of SFAS No. 157 for nonfinancial assets and liabilities within the scope of the new guidance is permitted. Key’s January 1, 2008, adoption of SFAS No. 157 for all financial and nonfinancial assets and

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liabilities did not have a material effect on Key’s financial condition or results of operations. Additional information regarding fair value measurements and Key’s adoption of this accounting guidance is provided in Note 15 and under the heading “Fair Value Measurements” on page 8 of this note.
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 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008, for Key). Key has elected to not apply this fair value option to any of its existing assets or liabilities. However, Key may apply this guidance to assets or liabilities in the future as permitted under SFAS No. 159.
Offsetting of amounts related to certain contracts. In April 2007, the FASB issued Staff Position FIN 39-1, which supplements Interpretation No. 39 by allowing reporting entities to offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash (a payable) arising from derivative instruments with the same counterparty. Interpretation No. 39 allowed reporting entities to offset fair value amounts recognized for derivative instruments executed with the same counterparty under a master netting agreement. Key did not previously adopt the provisions of Interpretation No. 39 that were permitted but not required. The accounting guidance in Staff Position FIN 39-1 is effective for fiscal years beginning after November 15, 2007 (January 1, 2008, for Key). Key has elected to adopt the accounting guidance in Staff Position FIN 39-1, and as a result, also adopted the provisions of Interpretation No. 39. The adoption of this accounting guidance did not have a material effect on Key’s financial condition or results of operations. Additional information regarding Key’s adoption of this accounting guidance is provided in Note 14 and under the heading “Derivatives” on page 8 of this note.
Determining the fair value of a financial asset when the market for that asset is not active. In October 2008, the FASB issued Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” This accounting guidance clarifies the application of SFAS No. 157 in determining the fair value of a financial asset when the market for that financial asset is not active. This Staff Position is effective upon issuance, and also applies to prior periods for which financial statements have not been issued. Therefore, it is effective for Key for the three months ended September 30, 2008. The adoption of this accounting guidance did not have a material effect on Key’s financial condition or results of operations.
Accounting Pronouncements Pending Adoption at September 30, 2008
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 Pending Adoption at December 31, 2007” on page 71 of Key’s 2007 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 (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.
Business combinations. In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” The new pronouncement requires the acquiring entity in a business combination to recognize only the assets acquired and liabilities assumed in a transaction (e.g., acquisition costs must be expensed when incurred), establishes the fair value at the date of acquisition as the initial measurement for all assets acquired and liabilities assumed, and requires expanded disclosures. SFAS No. 141(R) will be effective for fiscal years beginning after December 15, 2008 (January 1, 2009, for Key). Early adoption is prohibited.

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Noncontrolling interests. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51.” The new pronouncement requires all entities to report noncontrolling (minority) interests in subsidiaries as a component of shareholders’ equity. SFAS No. 160 will be effective for fiscal years beginning after December 15, 2008 (January 1, 2009, for Key). Early adoption is prohibited. Adoption of this accounting guidance is not expected to have a material effect on Key’s financial condition or results of operations.
Accounting for transfers of financial assets and repurchase financing transactions. In February 2008, the FASB issued Staff Position FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions.” This Staff Position provides guidance on accounting for a transfer of a financial asset and a repurchase financing, and presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (linked transaction) under SFAS No. 140. However, if certain criteria are met, the initial transfer and repurchase financing shall be evaluated separately under SFAS No. 140. Staff Position FAS 140-3 will be effective for fiscal years beginning after November 15, 2008 (January 1, 2009, for Key), and for interim periods within those fiscal years. Early adoption is prohibited. Adoption of this accounting guidance is not expected to have a material effect on Key’s financial condition or results of operations.
Disclosures about derivative instruments and hedging activities. In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” which amends and expands the disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This accounting guidance requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts and gains and losses on derivative instruments, and disclosures about credit risk-related contingent features in derivative agreements. SFAS No. 161 will be effective for fiscal years beginning after November 15, 2008 (January 1, 2009, for Key).
Determination of the useful life of intangible assets. In April 2008, the FASB issued Staff Position FAS 142-3, “Determination of the Useful Life of Intangible Assets.” This accounting guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” This Staff Position will be effective for fiscal years beginning after December 15, 2008 (January 1, 2009, for Key), and for interim periods within those fiscal years. Early adoption is prohibited. Adoption of this accounting guidance is not expected to have a material effect on Key’s financial condition or results of operations.
Hierarchy of generally accepted accounting principles. In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” This guidance identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with U.S. generally accepted accounting principles. SFAS No. 162 will be effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” Adoption of this accounting guidance is not expected to have a material effect on Key’s financial condition or results of operations.
Accounting for convertible debt instruments. In May 2008, the FASB issued Staff Position APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” This guidance requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) on conversion to separately account for the liability (debt) and equity (conversion option) components of the instrument in a manner that reflects the issuer’s nonconvertible debt borrowing rate. This Staff Position is effective for fiscal years beginning after December 15, 2008 (January 1, 2009, for Key), and for interim periods within those fiscal years. Early adoption is prohibited. Key has not issued and does not have any convertible debt instruments outstanding that are subject to the accounting guidance in this Staff Position. Therefore, adoption of this accounting guidance is not expected to have a material effect on Key’s financial condition or results of operations.

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Disclosures about credit derivatives and certain guarantees. In September 2008, the FASB issued Staff Position No. 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.” This Staff Position amends SFAS No. 133 to require additional disclosure about the potential adverse effects of changes in credit risk on the financial position, financial performance, and cash flows of the sellers of credit derivatives, including freestanding derivatives and derivatives embedded in hybrid instruments. This accounting guidance also amends Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others—an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34,” to require additional disclosure about the status of the payment/performance risk of guarantees. This Staff Position is effective for fiscal years ending after November 15, 2008 (December 31, 2008, for Key).
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   2008     2007     2008     2007  
 
EARNINGS
                               
(Loss) income from continuing operations
  $ (36 )   $ 224     $ (944 )   $ 919  
Loss from discontinued operations, net of taxes
          (14 )           (25 )
 
                       
 
Net (loss) income
  $ (36 )   $ 210     $ (944 )   $ 894  
 
                       
 
                               
Net (loss) income applicable to common shares
  $ (48 )   $ 210     $ (956 )   $ 894  
 
                       
 
WEIGHTED-AVERAGE COMMON SHARES
                               
Weighted-average common shares outstanding (000)
    491,179       389,319       435,846       393,048  
Effect of dilutive convertible preferred stock, common stock options
and other stock awards (000)
          3,845             4,768  
 
Weighted-average common shares and potential common shares outstanding (000)
    491,179       393,164       435,846       397,816  
 
                       
 
EARNINGS PER COMMON SHARE
                               
(Loss) income from continuing operations
  $ (.10 )   $ .58     $ (2.19 )   $ 2.34  
Loss from discontinued operations
          (.03 )           (.06 )
Net (loss) income
    (.10 )     .54       (2.19 )     2.28  
 
                               
(Loss) income from continuing operations — assuming dilution
  $ (.10 )   $ .57     $ (2.19 )   $ 2.31  
Loss from discontinued operations — assuming dilution
          (.03 )           (.06 )
Net (loss) income — assuming dilution
    (.10 )     .54       (2.19 )     2.25  
 
3. Acquisitions and Divestitures
Acquisitions and divestitures completed by Key during 2007 and the first nine months of 2008 are summarized below.
Acquisitions
U.S.B. Holding Co., Inc.
On January 1, 2008, Key acquired U.S.B. Holding Co., Inc., the holding company for Union State Bank, a 31-branch state-chartered commercial bank headquartered in Orangeburg, New York. U.S.B. Holding Co. had assets of $2.8 billion and deposits of $1.8 billion at the date of acquisition. Under the terms of the agreement, 9,895,000 KeyCorp common shares, with a value of $348 million, and $194 million in cash were exchanged for all of the outstanding shares of U.S.B. Holding Co. In connection with the acquisition, Key recorded goodwill of approximately $350 million. The acquisition expanded Key’s presence in markets both within and contiguous to its current operations in the Hudson Valley.

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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 transaction 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 subprime 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.
Key has applied discontinued operations accounting to the Champion Mortgage finance business. The results of this discontinued business are presented on one line as “loss from discontinued operations, net of taxes” in the Consolidated Statements of Income on page 4. The components of loss from discontinued operations are as follows:
                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
in millions   2007     2007  
 
Loss, net of taxes of ($2) and ($5), respectively a
  $ (3 )   $ (9 )
Loss on disposal, net of taxes of ($1)
          (1 )
Disposal transaction costs, net of taxes of ($6) and ($9), respectively
    (11 )     (15 )
 
Loss from discontinued operations
  $ (14 )   $ (25 )
 
           
 
(a)   Includes after-tax charges of $.06 million for the three-month period ended September 30, 2007, and $.7 million for the nine-month period ended September 30, 2007, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support Champion’s operations.
The discontinued assets and liabilities of Champion Mortgage included in the Consolidated Balance Sheets on page 3 are as follows:
                 
    December 31,     September 30,  
in millions   2007     2007  
 
Loans
  $ 8     $ 9  
Accrued income and other assets
          2  
 
Total assets
  $ 8     $ 11  
 
           
 
               
Accrued expense and other liabilities
  $ 10     $ 14  
 
Total liabilities
  $ 10     $ 14  
 
           
 
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 McDonald Investments’ 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 the registered broker-dealer through which its corporate and institutional investment banking and securities businesses operate to KeyBanc Capital Markets Inc.

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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 and Corporate Banking Services consists of two business units. Real Estate Capital is a national business that provides construction and interim lending, permanent debt placements and servicing, equity and investment banking, and other commercial banking products and services to developers, brokers and owner-investors. This unit deals primarily 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). Particular emphasis has been placed on providing clients with finance solutions through access to the capital markets.
Corporate Banking Services provides cash management, interest rate derivatives, and foreign exchange products and services to clients throughout the Community Banking and National Banking groups. Through its Public Sector and Financial Institutions businesses, Corporate Banking Services provides a full array of commercial banking products and services to government and not-for-profit entities, and to community banks.
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, through its KeyBanc Capital Markets unit, provides commercial lending, treasury management, investment banking, derivatives and foreign exchange, equity and debt underwriting and trading, and syndicated finance products and services to large corporations and middle-market companies.
Through its Victory Capital Management unit, Institutional and Capital Markets also manages or offers 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 provides government guaranteed education loans to students and their parents, and processes tuition payments for private schools. Through its Commercial Floor Plan Lending unit, this line of business also finances inventory for automobile dealers. Beginning in October 2008, Consumer Finance will exit direct and indirect retail and floor-plan lending for marine and recreational vehicle products and will limit new education loans to those backed by government guarantee. It will continue to service existing loans in these portfolios and to honor existing education loan commitments. These actions are consistent with Key’s strategy of de-emphasizing nonrelationship or out-of-footprint businesses.
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 16 and 17 shows selected financial data for each major business group for the three- and nine-month periods ended September 30, 2008 and 2007. 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 amount 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 67 of Key’s 2007 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, 2008, Key moved the Public Sector, Bank Capital Markets and Global Treasury Management units from the Institutional and Capital Markets line of business to the Real Estate Capital and Corporate Banking Services (previously known as Real Estate Capital) line of business within the National Banking group.

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Three months ended September 30,   Community Banking     National Banking  
dollars in millions   2008     2007     2008     2007  
 
SUMMARY OF OPERATIONS
                               
Net interest income (loss) (TE)
  $ 445     $ 412     $ 322     $ 355  
Noninterest income
    213       217       160  d     152  
 
Total revenue (TE) a
    658       629       482       507  
Provision for loan losses
    56       2       350       69  
Depreciation and amortization expense
    36       33       78       74  
Other noninterest expense
    409       380       264       253  
 
Income (loss) from continuing operations before income taxes (TE)
    157       214       (210 )     111  
Allocated income taxes and TE adjustments
    59       80       (77 )     41  
 
Income (loss) from continuing operations
    98       134       (133 )     70  
Loss from discontinued operations, net of taxes
                      (14 )
 
Net income (loss)
  $ 98     $ 134     $ (133 )   $ 56  
 
                       
 
                               
Percent of consolidated income from continuing operations
    N/M       60 %     N/M       31 %
Percent of total segments income from continuing operations
    N/M       61       N/M       32  
 
AVERAGE BALANCES b
                               
Loans and leases
  $ 28,872     $ 26,944     $ 47,075     $ 40,279  
Total assets a
    31,934       29,708       56,183       50,961  
Deposits
    50,384       46,729       12,439       12,631  
 
OTHER FINANCIAL DATA
                               
Net loan charge-offs
  $ 70     $ 19     $ 203     $ 40  
Return on average allocated equity b
    12.84 %     21.20 %     (10.28 )%     6.62 %
Return on average allocated equity
    12.84       21.20       (10.28 )     5.30  
Average full-time equivalent employees
    8,949       8,625       3,589       3,869  
 
                                 
Nine months ended September 30,   Community Banking     National Banking  
dollars in millions   2008     2007     2008     2007  
 
SUMMARY OF OPERATIONS
                               
Net interest income (loss) (TE)
  $ 1,307     $ 1,248     $ 184  d   $ 1,035  
Noninterest income
    642       819  c     606  d     684  d
 
Total revenue (TE) a
    1,949       2,067       790       1,719  
Provision for loan losses
    118       37       1,128       131  
Depreciation and amortization expense
    105       101       226       215  
Other noninterest expense
    1,218       1,222       760       759  
 
Income (loss) from continuing operations before income taxes (TE)
    508       707       (1,324 )     614  
Allocated income taxes and TE adjustments
    190       265       (495 )     230  
 
Income (loss) from continuing operations
    318       442       (829 )     384  
Loss from discontinued operations, net of taxes
                      (25 )
 
Net income (loss)
  $ 318     $ 442     $ (829 )   $ 359  
 
                       
 
                               
Percent of consolidated income from continuing operations
    N/M       48 %     N/M       42 %
Percent of total segments income from continuing operations
    N/M       50       N/M       43  
 
AVERAGE BALANCES b
                               
Loans and leases
  $ 28,483     $ 26,659     $ 46,374     $ 39,487  
Total assets a
    31,418       29,445       56,254       49,666  
Deposits
    50,035       46,459       12,205       12,008  
 
OTHER FINANCIAL DATA
                               
Net loan charge-offs
  $ 138     $ 64     $ 780     $ 92  
Return on average allocated equity b
    14.03 %     23.82 %     (21.68 )%     12.40 %
Return on average allocated equity
    14.03       23.82       (21.68 )     11.59  
Average full-time equivalent employees
    8,817       9,034       3,650       4,003  
 
(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’s results for the first quarter 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 12, for more information about this transaction.
 
(d)   National Banking’s results for the third quarter of 2008 include $54 million ($33 million after tax) of derivative-related charges recorded as a result of market disruption caused by the failure of Lehman Brothers and $31 million ($19 million after tax) of realized and unrealized losses from the residential properties segment of the construction loan portfolio. During the second quarter of 2008, National Banking’s taxable-equivalent net interest income and net income were reduced by $838 million and $536 million, respectively, as a result of an adverse federal court decision on the tax treatment of a Service Contract Lease transaction. During the first quarter of 2008, National Banking increased its tax reserves for certain lease in, lease out transactions and recalculated its lease income in accordance with prescribed accounting standards. These actions reduced National Banking’s taxable-equivalent revenue by $34 million and its net income by $21 million in the first quarter. National Banking’s results for the first quarter of 2007 include a $26 million ($17 million after tax) gain from the settlement of the residual value insurance litigation.

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Other Segments     Total Segments     Reconciling Items     Key  
2008     2007     2008     2007     2008     2007     2008     2007  
 
                                                             
$ (35 )   $ (24 )   $ 732     $ 743     $ (27 )   $ (31 )   $ 705     $ 712  
  18  e     39       391       408       (3 )     30  f     388       438  
 
  (17 )     15       1,123       1,151       (30 )     (1 )     1,093       1,150  
              406       71       1       (2 )     407       69  
              114       107                   114       107  
  (14 )     6       659       639       (11 )     7       648       646  
 
  (3 )     9       (56 )     334       (20 )     (6 )     (76 )     328  
  (12 )     (7 )     (30 )     114       (10 ) f     (10 )     (40 )     104  
 
  9       16       (26 )     220       (10 )     4       (36 )     224  
                    (14 )                       (14 )
 
$ 9     $ 16     $ (26 )   $ 206     $ (10 )   $ 4     $ (36 )   $ 210  
                                             
                                                             
  N/M       7 %     N/M       98 %     N/M       2 %     N/M       100 %
  N/M       7       N/M       100       N/A       N/A       N/A       N/A  
 
                                                             
$ 165     $ 245     $ 76,112     $ 67,468     $ 59     $ 212     $ 76,171     $ 67,680  
  13,803       12,523       101,920       93,192       1,236       1,970       103,156       95,162  
  1,965       3,203       64,788       62,563       (206 )     (42 )     64,582       62,521  
 
                                                             
            $ 273     $ 59                 $ 273     $ 59  
  N/M       N/M       (1.19 )%     12.10 %     N/M       N/M       (1.64 )%     11.50 %
  N/M       N/M       (1.19 )     11.33       N/M       N/M       (1.64 )     10.79  
  42       43       12,580       12,537       5,711       6,030       18,291       18,567  
 
 
Other Segments     Total Segments     Reconciling Items     Key  
2008     2007     2008     2007     2008     2007     2008     2007  
 
                                                             
$ (94 )   $ (70 )   $ 1,397     $ 2,213     $ (88 )   $ (95 )   $ 1,309     $ 2,118  
  71  e     167  e     1,319       1,670       152  f     71  f     1,471       1,741  
 
  (23 )     97       2,716       3,883       64       (24 )     2,780       3,859  
              1,246       168       (5 )     (2 )     1,241       166  
              331       316                   331       316  
  3       49  e     1,981       2,030       (37 )     6  f     1,944       2,036  
 
  (26 )     48       (842 )     1,369       106       (28 )     (736 )     1,341  
  (43 )     (15 )     (348 )     480       556  f     (58 )     208       422  
 
  17       63       (494 )     889       (450 )     30       (944 )     919  
                    (25 )                       (25 )
 
$ 17     $ 63     $ (494 )   $ 864     $ (450 )   $ 30     $ (944 )   $ 894  
                                             
                                                             
  N/M       7 %     N/M       97 %     N/M       3 %     N/M       100 %
  N/M       7       N/M       100       N/A       N/A       N/A       N/A  
 
                                                             
$ 193     $ 263     $ 75,050     $ 66,409     $ 124     $ 153     $ 75,174     $ 66,562  
  14,106       12,401       101,778       91,512       1,489       2,056       103,267       93,568  
  3,281       2,575       65,521       61,042       (190 )     (139 )     65,331       60,903  
 
                                                             
            $ 918     $ 156                 $ 918     $ 156  
  N/M       N/M       (7.63 )%     16.74 %     N/M       N/M       (14.66 )%     16.03 %
  N/M       N/M       (7.63 )     16.27       N/M       N/M       (14.66 )     15.59  
  43       43       12,510       13,080       5,784       6,001       18,294       19,081  
 
(e)   Other Segments’ results for the third quarter of 2008 include a $23 million ($14 million after tax) credit, representing the reversal of the remaining reserve associated with the Honsador litigation, which was settled in September. Other Segments’ results for the second quarter of 2007 include a $26 million ($16 million after tax) charge for litigation. This charge and the litigation charge referred to in note (f) below comprise the initial $42 million reserve established in connection with the Honsador litigation. Other Segments’ results for the first quarter of 2007 include a $49 million ($31 million after tax) loss from the repositioning of the securities portfolio.
 
(f)   Reconciling Items for the third and second quarters of 2008 include charges of $30 million and $475 million, respectively, to income taxes for the interest cost associated with the leveraged lease tax litigation. Reconciling Items for the first quarter of 2008 include a $165 million ($103 million after tax) gain from the partial redemption of Key’s equity interest in Visa Inc. and a $17 million charge to income taxes for the interest cost associated with the increase to Key’s tax reserves for certain LILO transactions. Reconciling Items for the third and second quarters of 2007 include gains of $27 million ($17 million after tax) and $40 million ($25 million after tax), respectively, related to MasterCard Incorporated shares. During the second quarter of 2007, Reconciling Items include a $16 million ($10 million after tax) charge for litigation.
TE = Taxable Equivalent
N/A = Not Applicable
N/M = Not Meaningful

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Supplementary information (Community Banking lines of business)
                                 
Three months ended September 30,   Regional Banking     Commercial Banking  
dollars in millions   2008     2007     2008     2007  
 
Total revenue (TE)
  $ 557     $ 534     $ 101     $ 95  
Provision for loan losses
    39       12       17       (10 )
Noninterest expense
    399       367       46       46  
Net income
    74       97       24       37  
Average loans and leases
    19,794       18,667       9,078       8,277  
Average deposits
    46,655       43,237       3,729       3,492  
Net loan charge-offs
    41       17       29       2  
Net loan charge-offs to average loans
    .82 %     .36 %     1.27 %     .10 %
Nonperforming assets at period end
  $ 168     $ 119     $ 57     $ 40  
Return on average allocated equity
    13.67 %     22.03 %     10.83 %     19.29 %
Average full-time equivalent employees
    8,603       8,264       346       361  
 
                                 
Nine months ended September 30,   Regional Banking     Commercial Banking  
dollars in millions   2008     2007     2008     2007  
 
Total revenue (TE)
  $ 1,646     $ 1,787     $ 303     $ 280  
Provision for loan losses
    77       50       41       (13 )
Noninterest expense
    1,187       1,179       136       144  
Net income
    239       349       79       93  
Average loans and leases
    19,659       18,546       8,824       8,113  
Average deposits
    46,361       43,006       3,674       3,453  
Net loan charge-offs
    103       55       35       9  
Net loan charge-offs to average loans
    .70 %     .40 %     .53 %     .15 %
Nonperforming assets at period end
  $ 168     $ 119     $ 57     $ 40  
Return on average allocated equity
    14.67 %     26.80 %     12.39 %     16.80 %
Average full-time equivalent employees
    8,470       8,666       347       368  
 
Supplementary information (National Banking lines of business)
                                                                 
    Real Estate Capital and                     Institutional and        
Three months ended September 30,   Corporate Banking Services     Equipment Finance     Capital Markets     Consumer Finance  
dollars in millions   2008     2007     2008     2007     2008     2007     2008     2007  
 
Total revenue (TE)
  $ 92     $ 128     $ 111     $ 138     $ 183     $ 156     $ 96     $ 85  
Provision for loan losses
    99       43       64       16       16       (2 )     171       12  
Noninterest expense
    89       88       90       93       107       105       56       41  
(Loss) income from continuing operations
    (60 )     (2 )     (27 )     18       37       34       (83 )     20  
Net (loss) income
    (60 )     (2 )     (27 )     18       37       34       (83 )     6  
Average loans and leases a
    16,447       14,160       10,012       10,681       8,364       6,716       12,252       8,722  
Average loans held for sale a
    792       1,584       49       6       649       373       161       2,729  
Average deposits a
    10,446       10,243       20       16       1,479       1,844       494       528  
Net loan charge-offs (recoveries)
    100       7       32       16       (1 )     6       72       11  
Net loan charge-offs (recoveries) to average loans a
    2.42 %     .20 %     1.27 %     .59 %     (.05 )%     .35 %     2.34 %     .50 %
Nonperforming assets at period end
  $ 714     $ 281     $ 115     $ 65     $ 58     $ 17     $ 127     $ 47  
Return on average allocated equity a
    (11.76 )%     (.56 )%     (11.99 )%     8.00 %     11.47 %     12.55 %     (35.09 )%     9.87 %
Return on average allocated equity
    (11.76 )     (.56 )     (11.99 )     8.00       11.47       12.55       (35.09 )     2.96  
Average full-time equivalent employees
    1,222       1,309       827       900       975       1,019       565       641  
 
                                                                 
    Real Estate Capital and                     Institutional and        
Nine months ended September 30,   Corporate Banking Services     Equipment Finance     Capital Markets     Consumer Finance  
dollars in millions   2008     2007     2008     2007     2008     2007     2008     2007  
 
Total revenue (TE)
  $ 405     $ 531     $ (488 )   $ 425     $ 570     $ 474     $ 303     $ 289  
Provision for loan losses
    509       51       124       45       69             426       35  
Noninterest expense
    219       264       274       272       335       307       158       131  
(Loss) income from continuing operations
    (202 )     135       (554 )     67       104       105       (177 )     77  
Net (loss) income
    (202 )     135       (554 )     67       104       105       (177 )     52  
Average loans and leases a
    16,676       13,838       10,310       10,590       7,966       6,612       11,422       8,447  
Average loans held for sale a
    799       1,327       44       7       566       325       1,209       2,672  
Average deposits a
    10,231       9,416       18       15       1,441       2,028       515       549  
Net loan charge-offs
    513       11       84       45       7       6       176       30  
Net loan charge-offs to average loans a
    4.11 %     .11 %     1.09 %     .57 %     .12 %     .12 %     2.06 %     .47 %
Nonperforming assets at period end
  $ 714     $ 281     $ 115     $ 65     $ 58     $ 17     $ 127     $ 47  
Return on average allocated equity a
    (13.37 )%     13.07 %     (81.32 )%     10.19 %     11.11 %     12.94 %     (25.42 )%     12.95 %
Return on average allocated equity
    (13.37 )     13.07       (81.32 )     10.19       11.11       12.94       (25.42 )     8.75  
Average full-time equivalent
employees
    1,227       1,293       841       893       949       1,023       633       794  
 
(a)    From continuing operations.
TE = Taxable Equivalent

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5. Securities
Securities available for sale. These are securities that Key intends to hold for an indefinite period of time but that may be sold in response to changes in interest rates, prepayment risk, liquidity needs or other factors. Securities available for sale 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 income (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.
Held-to-maturity 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 held-to-maturity portfolio are foreign bonds and preferred equity securities.
The amortized cost, unrealized gains and losses, and approximate fair value of Key’s securities available for sale and held-to-maturity 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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Table of Contents

                                 
    September 30, 2008  
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
in millions   Cost     Gains     Losses     Value  
         
SECURITIES AVAILABLE FOR SALE
                               
U.S. Treasury, agencies and corporations
  $ 10                 $ 10  
States and political subdivisions
    92           $ 2       90  
Collateralized mortgage obligations
    6,368     $ 113       13       6,468  
Other mortgage-backed securities
    1,511       25       2       1,534  
Retained interests in securitizations
    158       37             195  
Other securities
    98       3       7       94  
         
Total securities available for sale
  $ 8,237     $ 178     $ 24     $ 8,391  
 
                       
 
                               
         
HELD-TO-MATURITY SECURITIES
                               
States and political subdivisions
  $ 7                 $ 7  
Other securities
    21                   21  
         
Total held-to-maturity securities
  $ 28                 $ 28  
 
                       
         
                                 
    December 31, 2007  
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
in millions   Cost     Gains     Losses     Value  
         
SECURITIES AVAILABLE FOR SALE
                               
U.S. Treasury, agencies and corporations
  $ 19                 $ 19  
States and political subdivisions
    10                   10  
Collateralized mortgage obligations
    6,167     $ 33     $ 33       6,167  
Other mortgage-backed securities
    1,393       13       3       1,403  
Retained interests in securitizations
    149       36             185  
Other securities
    72       8       4       76  
 
Total securities available for sale
  $ 7,810     $ 90     $ 40     $ 7,860  
 
                       
 
                               
 
HELD-TO-MATURITY SECURITIES
                               
States and political subdivisions
  $ 9                 $ 9  
Other securities
    19                   19  
 
Total held-to-maturity securities
  $ 28                 $ 28  
 
                       
 
                                 
    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  
 
                       
 
                               
 
HELD-TO-MATURITY SECURITIES
                               
States and political subdivisions
  $ 15                 $ 15  
Other securities
    21                   21  
 
Total held-to-maturity securities
  $ 36                 $ 36  
 
                       
 

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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   2008     2007     2007  
 
Commercial, financial and agricultural
  $ 27,207     $ 24,797     $ 23,192  
Commercial real estate:
                       
Commercial mortgage
    10,569       9,630       9,272  
Construction
    7,708       8,102       8,214  
 
Total commercial real estate loans
    18,277  a     17,732       17,486  
Commercial lease financing
    9,437       10,176       10,309  
 
Total commercial loans
    54,921       52,705       50,987  
Real estate — residential mortgage
    1,898       1,594       1,583  
Home equity:
                       
Community Banking
    9,970       9,655       9,674  
National Banking
    1,101       1,262       1,230  
 
Total home equity loans
    11,071       10,917       10,904  
Consumer other — Community Banking
    1,274       1,298       1,308  
Consumer other — National Banking:
                       
Marine
    3,529       3,637       3,549  
Education
    3,711  b     331       334  
Other
    301       341       334  
 
Total consumer other — National Banking
    7,541       4,309       4,217  
 
Total consumer loans
    21,784       18,118       18,012  
 
Total loans
  $ 76,705     $ 70,823     $ 68,999  
 
                 
 
(a)   During the second quarter of 2008, Key transferred $384 million of commercial real estate loans ($719 million of primarily construction loans, net of $335 million in net charge-offs) from the loan portfolio to held-for-sale status.
 
(b)   On March 31, 2008, Key transferred $3.3 billion of education loans from loans held for sale to the loan portfolio.
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 2007 Annual Report to Shareholders.
Key’s loans held for sale by category are summarized as follows:
                         
    September 30,     December 31,     September 30,  
in millions   2008     2007     2007  
 
Commercial, financial and agricultural
  $ 159     $ 250     $ 67  
Real estate — commercial mortgage
    718       1,219       1,560  
Real estate — construction
    262  a     35       237  
Commercial lease financing
    52       1       5  
Real estate — residential mortgage
    57       47       36  
Home equity
          1       1  
Education
    223  b     3,176       2,877  
Automobile
    4       7       8  
 
Total loans held for sale
  $ 1,475     $ 4,736     $ 4,791  
 
                 
 
(a)   During the second quarter of 2008, Key transferred $384 million of commercial real estate loans ($719 million of primarily construction loans, net of $335 million in net charge-offs) from the loan portfolio to held-for-sale status.
 
(b)   On March 31, 2008, Key transferred $3.3 billion of education loans from loans held for sale to the loan portfolio.

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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   2008     2007     2008     2007  
 
Balance at beginning of period
  $ 1,421     $ 945     $ 1,200     $ 944  
Charge-offs
    (300 )     (82 )     (1,002 )     (218 )
Recoveries
    27       23       84       62  
 
Net loans charged off
    (273 )     (59 )     (918 )     (156 )
Provision for loan losses from continuing operations
    407       69       1,241       166  
Allowance related to loans acquired, net
                32        
Foreign currency translation adjustment
    (1 )           (1 )     1  
 
Balance at end of period
  $ 1,554     $ 955     $ 1,554     $ 955  
 
                       
 
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   2008     2007     2008     2007  
 
Balance at beginning of period
  $ 51     $ 50     $ 80     $ 53  
Provision (credit) for losses on lending-related commitments
    8       5       (21 )     3  
Charge-offs
                      (1 )
 
Balance at end of period a
  $ 59     $ 55     $ 59     $ 55  
 
                       
 
(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 but continues to service those loans 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   2008     2007  
 
Balance at beginning of period
  $ 313     $ 247  
Servicing retained from loan sales
    13       16  
Purchases
    4       122  
Amortization
    (75 )     (63 )
 
Balance at end of period
  $ 255     $ 322  
 
           
 
Fair value at end of period
  $ 412     $ 420  
 
           
 
The fair value of mortgage servicing assets is determined 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, 2008, and 2007, 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%.

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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, 2008, would cause a $9 million decrease in the fair value of Key’s mortgage servicing assets.
Contractual fee income from servicing commercial mortgage loans totaled $52 million and $54 million for the nine-month periods ended September 30, 2008 and 2007, respectively. The amortization of servicing assets for each year, as shown in the preceding table, 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.
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 FASB 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, 2008
                       
Low-income housing tax credit (“LIHTC”) funds
  $ 251     $ 158        
LIHTC investments
    N/A       717     $ 314  
 
N/A = Not Applicable
The third party 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 adjusts the financial statements each period for the third party investors’ share of the funds’ profits and losses. At September 30, 2008, the settlement value of these third party interests was estimated to be between $213 million and $247 million, while the recorded value, including reserves, totaled $264 million.
Key’s Principal Investing unit and the Real Estate Capital and Corporate Banking Services 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.
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 2007 Annual Report to Shareholders under the heading “Variable Interest Entities” on page 82.

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9. Nonperforming Assets and Past Due Loans
Impaired loans totaled $777 million at September 30, 2008, compared to $519 million at December 31, 2007, and $344 million at September 30, 2007. Impaired loans had an average balance of $703 million for the third quarter of 2008 and $240 million for the third quarter of 2007.
Key’s nonperforming assets and past due loans were as follows:
                         
    September 30,     December 31,     September 30,  
in millions   2008     2007     2007  
 
Impaired loans
  $ 777     $ 519     $ 344  
Other nonaccrual loans
    190       168       154  
 
Total nonperforming loans
    967  a     687       498  
 
                       
Nonperforming loans held for sale
    169  a     25       6  
 
                       
Other real estate owned (“OREO”)
    64       21       21  
Allowance for OREO losses
    (4 )     (2 )     (1 )
 
OREO, net of allowance
    60       19       20  
Other nonperforming assets b
    43       33       46  
 
Total nonperforming assets
  $ 1,239     $ 764     $ 570  
 
                 
 
Impaired loans with a specifically allocated allowance
  $ 678     $ 426     $ 35  
Specifically allocated allowance for impaired loans
    193       126       11  
 
Accruing loans past due 90 days or more
  $ 328     $ 231     $ 190  
Accruing loans past due 30 through 89 days
    937       843       717  
 
(a)   During the second quarter of 2008, Key transferred $384 million of commercial real estate loans ($719 million of primarily construction loans, net of $335 million in net charge-offs) from the loan portfolio to held-for-sale status.
 
(b)   Primarily investments held by the Private Equity unit within Key’s Real Estate Capital and Corporate Banking Services line of business.
At September 30, 2008, 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 67 of Key’s 2007 Annual Report to Shareholders.

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10. Capital Securities Issued by Unconsolidated Subsidiaries
KeyCorp owns the outstanding common stock 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 stock 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
 
¨   the amounts due if a trust is liquidated or terminated.
During the first quarter of 2008, the KeyCorp Capital X trust issued $740 million of securities. Also included in the table below are the capital securities held by the Union State Capital I, Union State Statutory II and Union State Statutory IV business trusts. The outstanding common stock of these trusts was owned by U.S.B. Holding Co., Inc., which Key acquired on January 1, 2008.
The capital securities, common stock 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   Stock     Net of Discount  b   Debentures  c   Debentures  
 
September 30, 2008
                                       
KeyCorp Capital I
  $ 197     $ 8     $ 201       3.531 %     2028  
KeyCorp Capital II
    187       8       183       6.875       2029  
KeyCorp Capital III
    236       8       214       7.750       2029  
KeyCorp Capital V
    172       5       194       5.875       2033  
KeyCorp Capital VI
    75       2       80       6.125       2033  
KeyCorp Capital VII
    249       8       268       5.700       2035  
KeyCorp Capital VIII
    260             282       7.000       2066  
KeyCorp Capital IX
    506             505       6.750       2066  
KeyCorp Capital X
    735             731       8.000       2068  
Union State Capital I
    20       1       21       9.580       2027  
Union State Statutory II
    20             20       6.379       2031  
Union State Statutory IV
    10             10       5.591       2034  
 
Total
  $ 2,667     $ 40     $ 2,709       6.820 %      
 
                                 
 
December 31, 2007
  $ 1,848     $ 39     $ 1,896       6.599 %      
 
                                 
 
September 30, 2007
  $ 1,782     $ 39     $ 1,874       6.611 %      
 
                                 
 
(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, 2008, December 31, 2007, and September 30, 2007, are basis adjustments of $84 million, $55 million and ($11) million, respectively, related to fair value hedges. See Note 19 (“Derivatives and Hedging Activities”), which begins on page 100 of Key’s 2007 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 31, 2006 (for debentures owned by Union State Statutory II); February 1, 2007 (for debentures owned by Union State Capital I); July 21, 2008

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    (for debentures owned by Capital V); December 15, 2008 (for debentures owned by Capital VI); April 7, 2009 (for debentures owned by Union State Statutory IV); June 15, 2010 (for debentures owned by Capital VII); June 15, 2011 (for debentures owned by Capital VIII); December 15, 2011 (for debentures owned by Capital IX); and March 15, 2013 (for debentures owned by Capital X); 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 Union State Statutory IV, Capital I, Capital V, Capital VI, Capital VII, Capital VIII, Capital IX or Capital X are redeemed before they mature, the redemption price will be the principal amount, plus any accrued but unpaid interest. If the debentures purchased by Union State Capital I are redeemed before they mature, the redemption price will be 104.31% of the principal amount, plus any accrued but unpaid interest. If the debentures purchased by Union State Statutory II are redeemed before they mature, the redemption price will be 104.5% of 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. Included in the principal amount of debentures at September 30, 2008, December 31, 2007, and September 30, 2007, are adjustments relating to hedging with financial instruments totaling $86 million, $64 million and $42 million, respectively.
 
(c)   The interest rates for Capital II, Capital III, Capital V, Capital VI, Capital VII, Capital VIII, Capital IX, Capital X and Union State Capital I are fixed. Capital I has a floating interest rate equal to three-month LIBOR plus 74 basis points that reprices quarterly. Union State Statutory II has a floating interest rate equal to three-month LIBOR plus 358 basis points that reprices quarterly. Union State Statutory IV has a floating interest rate equal to three-month LIBOR plus 280 basis points that reprices quarterly. The rates shown as the totals at September 30, 2008, December 31, 2007, and September 30, 2007, are weighted-average rates.
11. Employee Benefits
Pension Plans
The components of net pension cost for all funded and unfunded plans are as follows:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
in millions   2008     2007     2008     2007  
 
Service cost of benefits earned
  $ 13     $ 12     $ 39     $ 38  
Interest cost on projected benefit obligation
    15       15       47       44  
Expected return on plan assets
    (23 )     (22 )     (70 )     (66 )
Amortization of prior service cost
                1        
Amortization of losses
    4       7       10       21  
Curtailment gain
                      (3 )
 
Net pension cost
  $ 9     $ 12     $ 27     $ 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.
The components of net postretirement benefit (income) cost for all funded and unfunded plans are as follows:
                                 
    Three months ended     Nine months ended  
    September 30,     September 30,  
in millions   2008     2007     2008     2007  
 
Service cost of benefits earned
        $ 2     $ 1     $ 6  
Interest cost on accumulated postretirement benefit obligation
  $ 1       2       3       5  
Expected return on plan assets
    (2 )     (1 )     (4 )     (3 )
Amortization of unrecognized:
                               
Transition obligation
          1             3  
Prior service benefit
                (1 )      
Cumulative net gain
                (1 )      
 
Net postretirement benefit (income) cost
  $ (1 )   $ 4     $ (2 )   $ 11  
 
                       
 

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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 KEF leases the property rather than purchasing it. 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.
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. However, in subsequent years, the Internal Revenue Service (“IRS”) has challenged the tax treatment of these transactions by a number of bank holding companies and other corporations.
Currently, the IRS is auditing Key’s income tax returns for the 2004 through 2006 tax years. The IRS has completed audits of Key’s income tax returns for the 1995 through 2003 tax years and has disallowed all net deductions 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 the 1995-1997 tax years. Key paid the final assessment and filed a refund claim for the total amount. Key also has 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.
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. The case proceeded to a bench trial, which commenced on January 21, 2008. On May 28, 2008, the Court rendered a decision that was adverse to Key. Management disagreed with the decision and, on July 23, 2008, Key filed a notice of appeal to the United States Court of Appeals for the Sixth Circuit.
On August 6, 2008, the IRS announced an initiative for the settlement of all transactions that the IRS has characterized as LILO/SILO transactions (the “LILO/SILO Settlement Initiative”). As preconditions to its participation, Key was required to provide written acceptance to the IRS of the terms of the LILO/SILO Settlement Initiative and to dismiss its appeal of the AWG Leasing Litigation. While management continues to believe that the tax treatment applied to Key’s leveraged lease transactions complied with all

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tax laws, regulations and judicial authorities in effect at that time, it would take years of effort and expense to resolve this matter through litigation. Accordingly, Key has elected to participate in the LILO/SILO Settlement Initiative and has complied with the preconditions, including filing a dismissal of its appeal of the AWG Leasing Litigation. Key was accepted into the LILO/SILO Settlement Initiative by the IRS on October 6, 2008; however, Key’s acceptance is not binding until a closing agreement is executed by both Key and the IRS. Management believes that, upon the execution of a closing agreement, which could occur by year end, Key should realize an after-tax recovery of between $75 million and $100 million for previously accrued interest on disputed tax balances.
During the second quarter of 2008, Key concluded that the Court decision in the AWG Leasing Litigation, under applicable accounting guidance, had implications for the timing of the recognition of tax benefits on Key’s entire portfolio of LILO, QTE and Service Contract Leases. Therefore, management updated its assessment of Key’s tax position in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” and, as a result, Key increased the amount of its unrecognized tax benefits associated with all of the leases under challenge by the IRS by $2.15 billion. Key has deposited $1.975 billion (including $1.775 billion deposited with the IRS in October 2008) in response to the LILO/SILO Settlement Initiative to cover the anticipated amount of taxes due to the IRS for the tax years 1998 through 2006. Key also recorded a related $475 million charge to the provision for income taxes for the interest cost associated with the contested leases. Key did not recognize any charge for penalties or interest on penalties that the IRS has asserted or may assert in the future and, as a result of its participation in the LILO/SILO Settlement Initiative, does not expect to have to record any such charges.
The second quarter 2008 increase in unrecognized tax benefits associated with the contested leases necessitated a recalculation of Key’s lease income under FASB 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.” This resulted in a $536 million reduction of Key’s second quarter 2008 after-tax earnings, including a $359 million reduction to lease income and a $177 million increase to the provision for income taxes.
During the first quarter of 2008, Key increased the amount of its unrecognized tax benefits associated with its LILO transactions by $46 million. This adjustment resulted from an updated assessment of Key’s tax position performed by management in accordance with the provisions of FASB Interpretation No. 48. The increase in unrecognized tax benefits associated with Key’s LILO transactions also necessitated a recalculation of Key’s lease income under FASB Staff Position No. 13-2 and an increase to Key’s tax reserves. These actions reduced Key’s first quarter 2008 after-tax earnings by $38 million, including a $3 million reduction to lease income, an $18 million increase to the provision for income taxes and a $17 million charge to the tax provision for the associated interest charges.
During the third quarter of 2008, Key recorded a $30 million charge to the provision for income taxes for the interest cost associated with its contested LILO, QTE and Service Contract Lease transactions. As permitted under FASB Interpretation No. 48, it is Key’s policy to recognize interest and penalties related to unrecognized tax benefits in income tax expense. For the first nine months of 2008, Key recognized $836 million of pre-tax interest, of which $835 million ($522 million after tax) was attributable to the total unrecognized tax benefits associated with its LILO, QTE and Service Contract Lease transactions. Key’s liability for accrued interest payable was $853 million at September 30, 2008.
Key files United States federal income tax returns, as well as returns in various state and foreign jurisdictions. With the exception of the California and New York jurisdictions, Key is not subject to 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 or the execution of a closing agreement under the LILO/SILO Settlement Initiative will likely impact the recognition of benefits related to Key’s state and federal tax positions.

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13. Contingent Liabilities and Guarantees
Legal Proceedings
Lehman Brothers bankruptcy. On September 15, 2008, Lehman Brothers Holdings Inc. (“Holdings”) filed a petition in the United States Bankruptcy Court for the Southern District of New York for protection under Chapter 11 of the U.S. Bankruptcy Code. As of that date, both KeyCorp and KeyBank had outstanding interest rate swaps and other derivative transactions (collectively, the “Swap Transactions”) with Lehman Brothers Special Financing Inc. (“LBSF”), an affiliate of Holdings. Holdings guaranteed all of LBSF’s obligations under the Swap Transactions. Accordingly, the bankruptcy filing by Holdings constituted an Event of Default under the agreements governing the Swap Transactions, and both KeyCorp and KeyBank exercised their rights to terminate the Swap Transactions. In order to maintain its hedged position, Key entered into replacement contracts for the Swap Transactions with other parties. The aggregate net value of the Swap Transactions at the time of termination was in favor of Key. On October 3, 2008, LBSF filed its own petition in the United States Bankruptcy Court for the Southern District of New York for protection under Chapter 11 of the U.S. Bankruptcy Code. Key has filed claims against both LBSF and Holdings in the bankruptcy proceeding.
Taylor and Wildes litigation. On August 11, 2008, a purported class action case was filed against KeyCorp, its directors and certain employees (collectively, “Key”), captioned Taylor v. KeyCorp et al. in the United States District Court for the Northern District of Ohio. On September 16, 2008, a second and related case was filed in the same district court, captioned Wildes v. KeyCorp et al. The plaintiffs in these cases seek to represent a class of all participants in Key’s 401(k) Savings Plan and allege that Key breached fiduciary duties owed to them under the Employment Retirement Income Security Act (“ERISA”). Plaintiffs have filed a motion to consolidate the cases, pursuant to which they would be required to file a consolidated complaint within thirty days from the date the motion is granted. Key strongly disagrees with the allegations contained in the complaints and intends to vigorously defend against them.
Tax disputes. In the ordinary course of business, Key enters into 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 is included in Note 12 (“Income Taxes”), which begins on page 27.
Hondsador litigation. Key has previously disclosed information pertaining to a litigation matter involving its Key Principal Partners, LLC affiliate (“KPP”), in which KPP was sued in Hawaii state court in connection with its investment in a Hawaiian business. On May 23, 2007, in the case of Honsador Holdings LLC v. KPP, the jury returned a verdict in favor of the plaintiffs, and the court entered a final judgment in favor of the plaintiffs in the amount of $38.25 million. During the quarter ended June 30, 2007, Key established a reserve for the verdict, legal costs and other expenses associated with this lawsuit, and as of June 30, 2008, that reserve totaled approximately $47 million. Key had filed a notice of appeal with the Intermediate Court of Appeals for the State of Hawaii, but in September 2008, Key entered into a settlement agreement with the plaintiffs and withdrew its appeal in exchange for a complete settlement and release of the case by the plaintiffs. A notice of dismissal was entered into the court record on October 2, 2008. As a result of the settlement, Key reversed the remaining reserve in September 2008 as a reduction to expense.
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 does not believe there is any legal action to which KeyCorp or any of its subsidiaries is a party that, individually or in the aggregate, would reasonably be expected to have a material adverse effect on Key’s financial condition.

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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, 2008. 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 69 of Key’s 2007 Annual Report to Shareholders.
                 
    Maximum Potential        
    Undiscounted     Liability  
in millions   Future Payments     Recorded  
 
Financial guarantees:
               
Standby letters of credit
  $ 14,651     $ 38  
Recourse agreement with FNMA
    692       6  
Return guarantee agreement with LIHTC investors
    247       57  
Written interest rate caps a
    177       25  
Default guarantees
    12       1  
 
Total
  $ 15,779     $ 127  
 
           
 
(a)   As of September 30, 2008, the weighted-average interest rate of written interest rate caps was 2.8%, and the weighted-average strike rate was 5.0%. Maximum potential undiscounted future payments were calculated assuming a 10% interest rate.
Standby letters of credit. Many of Key’s lines of business issue standby letters of credit to address clients’ financing needs. These instruments 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. 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, 2008, Key’s standby letters of credit had a remaining weighted-average life of approximately 2.1 years, with remaining actual lives ranging from less than one year to as many as ten years.
Recourse agreement with Federal National Mortgage Association. KeyBank participates as a lender in the Federal National Mortgage Association (“FNMA”) Delegated Underwriting and Servicing 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, 2008, the outstanding commercial mortgage loans in this program had a weighted-average remaining term of 7.2 years, and the unpaid principal balance outstanding of loans sold by KeyBank as a participant in this program was approximately $2.2 billion. The maximum potential amount of undiscounted future payments that KeyBank may be required to make under this program is equal to approximately one-third of the principal balance of loans outstanding at September 30, 2008. If KeyBank is required to make a payment, it 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 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. Additional information regarding these partnerships is included in Note 8 (“Variable Interest Entities”) on page 23.

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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 30, KAHC maintained a reserve in the amount of $57 million at September 30, 2008, 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.
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, 2008, these caps had a weighted-average life of approximately 1.8 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 mitigates its potential future payments by entering into offsetting positions with third parties.
Default guarantees. Some lines of business provide or participate in 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 fourteen years. Although no collateral is held, Key would have recourse against the debtor for any payments made under a default guarantee.
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 Interpretation No. 45 and from other relationships.
Liquidity facilities that support asset-backed commercial paper conduits. Key provides liquidity facilities to several unconsolidated third-party commercial paper conduits. These facilities obligate Key to provide funding if there is a disruption in credit markets or other factors exist that preclude the issuance of commercial paper by the conduits. The liquidity facilities, all of which expire by November 10, 2010, obligate Key to provide aggregate funding of up to $995 million, with individual facilities ranging from $10 million to $125 million. The aggregate amount available to be drawn is based on the amount of current commitments to borrowers and totaled $799 million at September 30, 2008. At that date, $23 million had been drawn under these committed facilities. Key’s commitments to provide liquidity are periodically evaluated by management.
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. Key maintains reserves, when appropriate, with respect to liability it reasonably expects to incur in connection with these indemnities.
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.

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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. Derivative instruments are contracts between two or more parties. They have a notional amount and underlying variable, require no net investment and allow for the net settlement of positions. The notional amount serves as the basis for the payment provision of the contract and takes the form of units, such as shares or dollars. The underlying variable represents a specified interest rate, index or other component. The interaction between the notional amount and the underlying variable determines the number of units to be exchanged between the parties and drives the market value of the derivative contract.
The primary derivatives that Key uses are interest rate swaps and caps, foreign exchange contracts, energy derivatives, credit derivatives and equity derivatives. Generally, these instruments help Key manage exposure to market risk, mitigate the credit risk inherent in the loan portfolio and meet client financing and hedging 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.
Derivative assets and liabilities are recorded at fair value on the balance sheet, after taking into account the effects of master netting agreements. These agreements allow Key to settle all derivative contracts held with a single counterparty on a net basis, and to offset net derivative positions with the related cash collateral. As a result, Key could have derivative contracts with negative fair values included in derivative assets on the balance sheet and contracts with positive fair values included in derivative liabilities.
At September 30, 2008, Key had $292 million of derivative assets and $130 million of derivative liabilities that relate to contracts entered into for hedging purposes. As of the same date, Key had trading derivative assets of $659 million and trading derivative liabilities of $459 million.
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 after taking into account the effects of master netting agreements and other means used to mitigate risk.
                         
    September 30,     December 31,     September 30,  
in millions   2008     2007     2007  
 
Interest rate
  $ 794     $ 850     $ 395  
Foreign exchange
    260       492       400  
Energy
    139       52       18  
Credit
    36       13       3  
Equity
    3       34       16  
 
Derivative assets before cash collateral
    1,232       1,441       832  
Less: Related cash collateral
    281       562       293  
 
Total derivative assets
  $ 951     $ 879     $ 539  
 
                 
 
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, a broker-dealer or a client, fails to meet its contractual obligations. This risk is measured as the expected positive replacement value of contracts on the date of the default. During the third quarter of 2008, Key recorded a $54 million pre-tax loss as a result of the failure of Lehman Brothers and the inability of one of its subsidiaries to meet its contractual obligations.
Key uses several means to mitigate credit risk and manage exposure to credit risk on derivative contracts. Key generally enters into bilateral collateral and master netting agreements using standard forms published by the International Swaps and Derivatives Association (“ISDA”). These agreements provide for the net settlement of all contracts with a single counterparty in the event of default. Additionally, Key monitors credit risk

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exposure to the counterparty on each contract to determine appropriate limits on Key’s total credit exposure. Key reviews its collateral positions on a daily basis and exchanges collateral with its counterparties in accordance with ISDA and other related agreements. Key generally holds collateral in the form of cash and highly rated securities issued by the U.S. Treasury, government sponsored enterprises or the Government National Mortgage Association. The cash collateral netted against derivative assets on the balance sheet was $281 million at September 30, 2008, $562 million at December 31, 2007, and $293 million at September 30, 2007. The cash collateral netted against derivative liabilities was $348 million at September 30, 2008, $254 million at December 31, 2007, and $114 million at September 30, 2007.
At September 30, 2008, Key’s derivative contracts included interest rate swaps and caps, foreign exchange contracts, energy derivatives, credit derivatives and equity derivatives. Key’s aggregate gross exposure on these instruments totaled $2.6 billion. However, after taking into account the effects of master netting agreements and cash collateral held, Key had net exposure of $951 million as shown in the table on page 32. Key’s net exposure at September 30, 2008, was further reduced to $876 million by $75 million of additional collateral held in the form of securities. The largest gross exposure to an individual counterparty was $239 million, which was secured with $164 million in collateral. Additionally, Key had a derivative liability of $55 million with this counterparty that, when netted against the gross exposure under a master netting agreement, resulted in net exposure of $20 million.
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 2007 Annual Report to Shareholders.
The change in “accumulated other comprehensive income (loss)” resulting from cash flow hedges is as follows:
                                 
                    Reclassification        
    December 31,     2008     of Gains to     September 30,  
in millions   2007     Hedging Activity     Net Income     2008  
 
Accumulated other comprehensive income (loss) resulting from cash flow hedges
  $ 103     $ 69     $ (93 )   $ 79  
 
Key reclassifies gains and losses from “accumulated other comprehensive income (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. If interest rates, yield curves and notional amounts remain at September 30, 2008, levels, management would expect to reclassify an estimated $64 million of net gains on derivative instruments from “accumulated other comprehensive income (loss)” to earnings during the next twelve months. The maximum length of time over which forecasted transactions are hedged is twenty years.
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, 2008, the notional amount of credit default swaps purchased by Key was $1.3 billion. Key also provides credit protection to other lenders through the sale of credit default swaps. In most instances, this is accomplished through the use of an investment-grade diversified dealer-traded basket of credit default swaps. These transactions may generate fee income and can diversify and reduce overall portfolio credit risk volatility. At September 30, 2008, the notional amount of credit default swaps sold by Key was $343 million.

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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.
Trading Portfolio
Key’s trading portfolio is composed of the following instruments:
¨   interest rate swap, cap, floor and futures contracts entered into to accommodate the needs of clients;
 
¨   commodity swap and options contracts entered into to accommodate the needs of clients;
 
¨   positions with third parties that are intended to offset or mitigate the market risk related to client positions discussed above;
 
¨   foreign exchange forward contracts entered into to accommodate the needs of clients; and
 
¨   interest rate, foreign currency and credit default swaps for proprietary purposes.
The fair values of these trading portfolio items are included in “derivative assets” or “derivative liabilities” on the balance sheet. Key does not apply hedge accounting to any of these contracts. Adjustments to the fair values are included in “investment banking and capital markets (loss) income” on the income statement. In addition to the collateral exchange agreements previously discussed, Key has established a reserve in the amount of $19 million at September 30, 2008, 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 2007 Annual Report to Shareholders.

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15. Fair Value Measurements
Effective January 1, 2008, Key adopted SFAS No. 157, “Fair Value Measurements,” for all applicable financial and nonfinancial assets and liabilities. This accounting guidance defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 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. Additional information pertaining to Key’s accounting policy for fair value measurements is summarized in Note 1 (“Basis of Presentation”) under the heading “Fair Value Measurements” on page 8.
Fair Value Determination
As defined in SFAS No. 157, fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants in Key’s principal market. Key has established and documented its process for determining the fair values of its assets and liabilities, where applicable. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, management determines the fair value of Key’s assets and liabilities using valuation models or third-party pricing services, both of which rely on market-based parameters when available, such as interest rate yield curves, option volatilities and credit spreads, or unobservable inputs. Unobservable inputs may be based on management’s judgment, assumptions and estimates related to credit quality, liquidity, interest rates and other relevant inputs.
Valuation adjustments, such as those pertaining to counterparty and Key’s own credit quality and liquidity, may be necessary to ensure that assets and liabilities are recorded at fair value. Credit valuation adjustments are made when market pricing is not indicative of the counterparty’s credit quality. Most classes of derivative contracts are valued using internally-developed models based on market-standard derivative pricing conventions, which rely primarily on observable market inputs, such as interest rate yield curves and volatilities. Market convention implies a credit rating of double-A equivalent in the pricing of derivative contracts, which assumes all counterparties have the same creditworthiness. In determining the fair value of derivatives, management applies cash collateral and/or a default reserve to reflect the credit quality of the counterparty.
Liquidity valuation adjustments are made when management is unable to observe recent market transactions for identical or similar instruments. Management adjusts the fair value to reflect the uncertainty in the pricing and trading of the instrument. Liquidity valuation adjustments are based on the following factors:
¨   the amount of time since the last relevant valuation;
 
¨   whether there is an actual trade or relevant external quote available at the measurement date; and
 
¨   volatility associated with the primary pricing components.
Key has various controls in place to ensure that fair value measurements are accurate and appropriate. These controls include:
¨   an independent review and approval of valuation models;
 
¨   a detailed review of profit and loss conducted on a regular basis; and
 
¨   validation of valuation model components against benchmark data and similar products, where possible.
Any changes to valuation methodologies are reviewed by management to ensure they are relevant and justified. Valuation methodologies are refined as more market-based data becomes available.

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Fair Value Hierarchy
SFAS No. 157 establishes a three-level valuation hierarchy for determining fair value that is based on the transparency of the inputs used in the valuation process. The inputs used in determining fair value in each of the three levels of the hierarchy are as follows:
¨   Level 1. Quoted prices (unadjusted) in active markets for identical assets or liabilities.
 
¨   Level 2. Either: (i) quoted market prices for similar assets or liabilities; (ii) observable inputs, such as interest rates or yield curves; or (iii) inputs derived principally from or corroborated by observable market data.
 
¨   Level 3. Unobservable inputs.
The hierarchy gives the highest ranking to Level 1 inputs and the lowest ranking to Level 3 inputs. The level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the overall fair value measurement.
Qualitative Disclosures of Valuation Techniques
Loans. Loans recorded as trading account assets are valued based on market spreads for identical or similar assets. Generally, these loans are classified as Level 2 since the fair value recorded is based on observable market data. Key corroborates these inputs periodically through a pricing service, which obtains data about actual transactions in the marketplace for identical or similar assets.
Securities (trading and available for sale). Where quoted prices are available in an active market, securities are classified as Level 1. Level 1 instruments include highly liquid government bonds, securities issued by the U.S. Treasury and exchange-traded equity securities. If quoted prices are not available, management determines fair value using pricing models, quoted prices of similar securities or discounted cash flows. These instruments include assets such as municipal bonds and certain agency collateralized mortgage obligations and are classified as Level 2. In certain cases where there is limited activity in the market for a particular instrument, assumptions must be made to determine their fair value. Such instruments include certain mortgage-backed securities, certain commercial paper and restricted stock, and are classified as Level 3.
Private equity and mezzanine investments. Valuations of private equity and mezzanine investments, held primarily within Key’s Real Estate Capital and Corporate Banking Services line of business, are based primarily on management’s judgment due to the lack of readily determinable fair values, inherent illiquidity and the long-term nature of these assets. These investments are initially valued based upon the transaction price. The carrying amount is then adjusted upward or downward based upon the estimated future cash flows associated with the investments. Factors used in determining future cash flows include, but are not limited to, the cost of build-out, future selling prices, current market outlook and operating performance of the particular investment. Private equity and mezzanine investments are classified as Level 3.
Principal investments. Valuations of principal investments, made by KPP, are based on the underlying investments of the fund. In the case of equity securities where readily available market quotes exist, those market quotes are utilized, and the related investments are classified as Level 1. Most of KPP’s investments are in private companies without readily available market data. For these investments, the inputs are classified as Level 3 and are used in valuation methodologies such as discounted cash flows, price/earnings ratios, and multiples of earnings before interest, tax, depreciation and amortization.
Derivatives. Exchange-traded derivatives are valued using quoted prices and, therefore, are classified as Level 1. Only a few types of derivatives are exchange-traded; thus, the majority of Key’s derivative positions are valued using internally-developed models that use observable market inputs. These derivative contracts are classified as Level 2 and include interest rate swaps, options and credit default

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swaps. Market convention implies a credit rating of double-A equivalent in the pricing of derivative contracts, which assumes all counterparties have the same creditworthiness. In order to reflect the actual exposure on Key’s derivative contracts related to both counterparty and Key’s own creditworthiness, management records a fair value adjustment in the form of a reserve. The credit component is valued on a counterparty-by-counterparty basis and considers master netting agreements and collateral.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities are considered to be fair valued on a recurring basis if fair value is measured regularly (i.e., daily, weekly, monthly or quarterly). The following table shows Key’s assets and liabilities measured at fair value on a recurring basis.
                                         
September 30, 2008                           Netting        
in millions   Level 1     Level 2     Level 3     Adjustments  a   Total  
 
ASSETS MEASURED ON A RECURRING BASIS
                                       
Trading account assets
  $ 16     $ 653     $ 780           $ 1,449  
Securities available for sale
    77       8,118                   8,195  
Other investments
    26       8       1,172             1,206  
Derivative assets
    434       2,112       9     $ (1,604 )     951  
Accrued income and other assets
    3       5                   8  
 
Total assets on a recurring basis at fair value
  $ 556     $ 10,896     $ 1,961     $ (1,604 )   $ 11,809  
 
                             
 
 
                                       
LIABILITIES MEASURED ON A RECURRING BASIS
                                   
Bank notes and other short-term borrowings
  $ 30     $ 158                 $ 188  
Derivative liabilities
    418       1,842     $ 1     $ (1,672 )     589  
 
Total liabilities on a recurring basis at fair value
  $ 448     $ 2,000     $ 1     $ (1,672 )   $ 777  
 
                             
 
(a)   Netting adjustments represent the amounts recorded to convert Key’s derivative assets and liabilities from a gross basis to a net basis in conjunction with Key’s January 1, 2008, adoption of FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts,” and FASB Staff Position FIN 39-1, “Amendment of FASB Interpretation 39.” The net basis takes into account the impact of master netting agreements which allow Key to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related cash collateral.
Changes in Level 3 Fair Value Measurements
The following table shows the change in the fair values of Key’s Level 3 financial instruments for the nine months ended September 30, 2008. Classification in Level 3 is based on the significance of unobservable inputs relative to the overall fair value measurement of the instrument. In addition to unobservable inputs, Level 3 instruments also may have inputs that are observable within the market. Management mitigates the credit risk, interest rate risk and risk of loss related to many of these Level 3 instruments through the use of securities and derivative positions classified as Level 1 or Level 2. Level 1 or Level 2 instruments are not included in the following table; therefore, the gains or losses shown do not include the impact of Key’s risk management activities related to these Level 3 instruments.
                                 
    Nine months ended September 30, 2008
    Trading     Securities              
    Account     Available     Other     Derivative  
in millions   Assets     for Sale     Investments     Instruments  a
 
Balance at beginning of period
  $ 338     $ 4     $ 1,161     $ 6  
(Losses) gains:
                               
Included in earnings
    (48 b     3  c     (8 d     3   b
Included in other comprehensive income
          (2 )            
Purchases, sales, issuances and settlements
    490       (5 )     32       (1 )
Net transfers out of Level 3
                (13 )      
 
Balance at end of period
  $ 780           $ 1,172     $ 8  
 
                       
 
 
                               
Unrealized (losses) gains included in earnings
  $ (38 ) b         $ (22 ) d   $ 3  b
 
(a)   Amount represents Level 3 derivative assets less Level 3 derivative liabilities.
 
(b)   Realized and unrealized gains and losses on trading account assets and derivative instruments are reported in “investment banking and capital markets income” on the income statement.
 
(c)   Unrealized gains and losses on securities available for sale are reported in “net securities (losses) gains” on the income statement.
 
(d)   Other investments consist of principal investments, and private equity and mezzanine investments. Realized and unrealized gains and losses on principal investments are reported in “net (losses) gains from principal investments” on the income statement. Realized and unrealized gains and losses on private equity and mezzanine investments are reported in “investment banking and capital markets (loss) income” on the income statement.

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Assets Measured at Fair Value on a Nonrecurring Basis
Assets and liabilities are considered to be fair valued on a nonrecurring basis if the fair value measurement of the instrument does not necessarily result in a change in the amount recorded on the balance sheet. Generally, nonrecurring valuation is the result of the application of other accounting pronouncements which require assets or liabilities to be assessed for impairment or recorded at the lower of cost or fair value. The following table presents Key’s assets measured at fair value on a nonrecurring basis.
                                 
September 30, 2008                        
in millions   Level 1     Level 2     Level 3     Total  
 
ASSETS MEASURED ON A NONRECURRING BASIS
                               
Securities available for sale
              $ 4     $ 4  
Other investments
                1       1  
Loans
                54       54  
Loans held for sale
                459       459  
Goodwill
                47       47  
Accrued income and other assets
        $ 5       52       57  
 
Total assets on a nonrecurring basis at fair value
        $ 5     $ 617     $ 622  
 
                       
 
Through Key’s quarterly analysis of its commercial and construction loan portfolios held for sale, management determined that certain adjustments were necessary to record the portfolios at the lower of cost or fair value in accordance with GAAP. After adjustments, these loans totaled $459 million at September 30, 2008. Valuation of these loans is performed using an internal model which relies on market data from sales of similar assets, including credit spreads, interest rate curves and risk profiles, as well as Key’s own assumptions about the exit market for the loans. The valuation methodology employed is based on Level 3 inputs. Key’s loans held for sale, which are measured at fair value on a nonrecurring basis, include the remaining $133 million of commercial real estate loans transferred from the loan portfolio to held-for-sale status in June 2008. The fair value of these loans was measured using nonbinding broker quotes obtained through a third party. Additionally, during the third quarter of 2008, Key transferred $54 million of commercial loans from held for sale to the loan portfolio at their current fair value.
Other real estate owned and other repossessed properties are valued based on appraisals and third-party price opinions, less estimated selling costs. Assets that are acquired through, or in lieu of, loan foreclosures are recorded as held for sale initially at the lower of the loan balance or fair value upon the date of foreclosure. Subsequent to foreclosure, valuations are updated periodically, and the assets may be marked down further, reflecting a new cost basis. These assets, which totaled $50 million at September 30, 2008, are considered to be nonrecurring items in the fair value hierarchy.
Current market conditions, including lower prepayments, interest rates and expected recovery rates have impacted Key’s modeling assumptions pertaining to education lending-related servicing rights and residual interests, and consequently resulted in write-downs of these instruments. These instruments are included in “accrued income and other assets” and “securities available for sale,” respectively, in the preceding table.

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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, 2008 and 2007, and the related condensed consolidated statements of income, for the three- and nine-month periods then ended, and the condensed consolidated statement of changes in shareholders’ equity and cash flows for the nine-month periods ended September 30, 2008 and 2007. 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, 2007, 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 22, 2008, 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, 2007, 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 4, 2008

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Item 2. Management’s Discussion and Analysis of Financial Condition and 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, 2008 and 2007. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends in greater depth. When you read this discussion, you should also refer to the consolidated financial statements and related notes that appear on pages 3 through 38. A description of Key’s business is included under the heading “Description of Business” on page 14 of Key’s 2007 Annual Report to Shareholders. This description does not reflect the reorganization within some of Key’s lines of business that took effect on January 1, 2008. For a current description of Key’s lines of business, see Note 4 (“Line of Business Results”), which begins on page 14.
Terminology
This report contains some shortened names and industry-specific terms. We want to explain some of these terms at the outset so you can better understand 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 subprime mortgage loan portfolio held by the Champion Mortgage finance business and announced a separate agreement to sell Champion’s 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 primarily through business conducted by the National Banking group. 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).
 
¨   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. You will find a more detailed explanation of total and Tier 1 capital and how they are calculated in the section entitled “Capital,” which begins on page 74.

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Forward-looking statements
This report and other reports filed by Key under the Securities Exchange Act of 1934 or registration statements filed by Key under the Securities Act of 1933 contain statements that are considered “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about Key’s 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.
 
¨   Unprecedented volatility 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.
 
¨   There can be no assurance as to the actual impact that the Emergency Economic Stabilization Act of 2008 (“EESA”) or other initiatives undertaken by the U.S. government through the federal regulatory agencies will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect Key’s business, financial condition, results of operations, access to credit or the trading price of Key’s common stock.
 
¨   Key’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions.
 
¨   Recent problems in the housing markets, including issues related to the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, and related conditions in the financial markets, or other issues, such as the price of oil or other commodities, could cause further 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.
 
¨   Increasing interest rates or further weakening economic conditions could constrain borrowers’ ability to repay outstanding loans or diminish the value of the collateral securing those loans. Additionally, the allowance for loan losses may be insufficient if the estimates and judgments management used to establish that allowance prove to be inaccurate.
 
¨   Increased competitive pressure among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies may adversely affect Key’s ability to market its products and services.

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¨   Key may become subject to new or heightened legal standards and regulatory requirements, practices or expectations which may impede its profitability or affect its financial condition, including new regulations imposed in connection with the Troubled Asset Relief Program (“TARP”) provisions of the EESA being implemented and administered by the U.S. Treasury Department (“U.S. Treasury”) in coordination with other federal regulatory agencies, further laws enacted by the U.S. Congress in an effort to strengthen the fundamentals of the U.S. economy, or other regulations promulgated by federal regulators to mitigate the systemic risk presented by the current financial crisis.
 
¨   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.
 
¨   Increases in deposit insurance premiums imposed by the Federal Deposit Insurance Corporation (“FDIC”) on KeyBank due to the FDIC’s restoration plan for the Deposit Insurance Fund announced on October 7, 2008, and continued difficulties experienced by other financial institutions may have an adverse effect on Key’s results of operations.
 
¨   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.
 
¨   Changes in accounting principles or in tax laws, rules and regulations could have an adverse effect on Key’s financial results or its capital.
 
¨   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.
 
¨   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.
Forward-looking statements are not historical facts but instead represent only management’s current expectations and forecasts regarding future events, many of which, by their nature, are inherently uncertain and outside of Key’s control. The factors discussed above and in the section entitled “Item 1A. Risk Factors,” which begins on page 95, are not intended to be a complete summary of all risks and uncertainties that may affect Key’s business, the financial services industry and financial markets. Though management strives to monitor and mitigate risk, management cannot anticipate all potential economic, operational and financial developments that may have an adverse impact on Key’s operations and financial results. Forward-looking statements speak only as to the date the statement is made, and Key does not undertake any obligation to revise any forward-looking statement to reflect subsequent events.
Before making an investment decision, you should carefully consider all risks and uncertainties disclosed in Key’s SEC filings, including this and Key’s other reports on Forms 8-K, 10-K and 10-Q and our registration statements under the Securities Act of 1933, all of which are accessible on the SEC’s website at www.sec.gov.
Long-term goals
Key’s long-term financial goals are to grow its earnings per common share and achieve a return on average equity, each at or above the respective median of its peer group. The strategy for achieving these goals is described under the heading “Corporate Strategy” on page 16 of Key’s 2007 Annual Report to Shareholders.
Economic overview
During the third quarter of 2008, financial markets were severely strained as the fallout from the housing market and the recognition of losses by financial institutions continued. Home sales remained weak even in the face of improved housing affordability and falling home values. The median price of existing homes fell by more than 9.0% from the respective price levels reported for the same month last year. Lower prices

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were partly a consequence of the elevated levels of foreclosures, which rose by 21% from the number of foreclosures experienced in September 2007. September new home sales were down 33% from one year ago and existing home sales were relatively flat for the same period. In response, homebuilder activity declined as housing starts hit a 17-year low, falling more than 30% from September 2007.
Further write-downs caused by distressed real estate values and increasing loan losses continued to pressure capital levels at financial institutions, forcing many to raise additional capital, often at substantially higher costs than in recent years. Some financial institutions were forced into liquidation or mergers as losses mounted, and the availability of funding and capital remained restricted. As concern over the strength of their peers’ balance sheets increased, banks curbed lending to each other, and short-term unsecured lending rates rose. Short-term interbank lending rates increased by 127 basis points during the quarter, while the yield on short-term Treasury bills declined by 83 basis points. For regional banking institutions such as Key, there were no cost-effective means of accessing capital markets for unsecured term debt.
Early in the third quarter, inflationary pressures intensified before showing signs of subsiding. Most of the reduction came from lower oil prices, which declined to $101 per barrel at September 30, 2008, after reaching an all time high of $145 per barrel in early July 2008. Consumer prices in September 2008 rose 4.9% from September 2007, down slightly from a 5.0% annual increase in June 2008. Employment continued to weaken in the third quarter as the economy lost 299,000 jobs, which brought the number of jobs lost since December 2007 to 760,000. The average unemployment rate for the quarter rose to 6.0%, compared to the second quarter average of 5.3% and the 2007 average of 4.6%. The positive impact from the second quarter 2008 tax rebate checks dissipated in the third quarter. Consumer spending during the third quarter declined at an average monthly rate of .1%, compared to an average monthly rate increase of .5% in the second quarter of 2008.
While the downside risks to the economy increased during the third quarter of 2008, the Federal Reserve held the federal funds target rate at 2.00%, mainly due to elevated inflationary pressures. Meanwhile, as investors looked for safe-haven as the financial crisis continued, the benchmark two-year Treasury yield decreased to 1.96% at September 30, 2008, from 2.62% at June 30, 2008, and the ten-year Treasury yield, which began the third quarter at 3.97%, closed the quarter at 3.83%. In an effort to alleviate strains in the financial markets and increase liquidity available to U.S. financial institutions, the Federal Reserve expanded many of its liquidity programs, and together with the U.S. Treasury and the FDIC, took a variety of unprecedented actions. In September, the Federal Housing Finance Agency, with the support of the U.S. Treasury, placed Fannie Mae and Freddie Mac, two government-sponsored enterprises that play a critical role in the U.S. home mortgage market, in conservatorship, taking full management control. The Federal Reserve seized control of insurance giant American International Group Inc. in September, and provided traditional investment banks the authority to become bank holding companies and to access the discount window of the Federal Reserve. On October 3, 2008, President Bush signed into law the EESA, which is intended to restore liquidity and stability to the U.S. financial system through the purchase of up to $700 billion of certain mortgages, mortgage-backed securities and other financial instruments (including preferred equity). On October 8, 2008, as falling oil prices tempered inflationary concerns and liquidity concerns remained, the Federal Reserve, as part of a coordinated effort with six other central banks to stabilize world markets, lowered the federal funds target rate to 1.50%. On October 14, 2008, the FDIC announced its Temporary Liquidity Guarantee Program, including its debt guarantee program for qualifying newly issued senior unsecured debt of insured depository institutions, their holding companies and certain other affiliates of insured depository institutions designated by the FDIC (the “Debt Guarantee”), and a transaction account guarantee for funds held at FDIC-insured depository institutions in noninterest-bearing transaction accounts in excess of the current standard maximum deposit insurance amount of $250,000 (the “Transaction Account Guarantee”). Finally, on October 29, 2008, the Federal Reserve further lowered the federal funds target rate to 1.00%.
Demographics. The extent to which Key’s business has been affected by continued volatility and weakness in the housing market is directly related to the state of the economy in the regions in which its two major business groups, Community Banking and National Banking, operate.

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Key’s Community Banking group serves consumers and small to mid-sized businesses by offering a variety of deposit, investment, lending and wealth management products and services. These products and services are provided through a 14-state branch network organized into four geographic regions as defined by management: Northwest, Rocky Mountains, Great Lakes and Northeast. Figure 1 shows the geographic diversity of the Community Banking group’s average core deposits, commercial loans and home equity loans. As of September 30, 2008, approximately two-thirds of the loans and deposits held by Community Banking were outside of the Great Lakes region, which has been particularly hard hit by the weakening economy. The Community Banking group continues to benefit from its geographic diversity. Compared to the third quarter of 2007, this business experienced growth in both revenue and deposits, with revenue increases coming from each of the group’s 23 districts.
Figure 1. Community Banking Geographic Diversity
                                                 
    Geographic Region              
Three months ended September 30, 2008           Rocky                          
dollars in millions   Northwest     Mountains     Great Lakes     Northeast     Nonregion  a   Total  
 
Average core deposits
  $ 9,824     $ 3,506     $ 14,219     $ 13,243     $ 1,524     $ 42,316  
Percent of total
    23.2 %     8.3 %     33.6 %     31.3 %     3.6 %     100.0 %
 
                                               
Average commercial loans
  $ 4,420     $ 2,032     $ 4,920     $ 3,281     $ 1,358     $ 16,011  
Percent of total
    27.6 %     12.7 %     30.7 %     20.5 %     8.5 %     100.0 %
 
                                               
Average home equity loans
  $ 2,855     $ 1,379     $ 2,905     $ 2,621     $ 127     $ 9,887  
Percent of total
    28.9 %     13.9 %     29.4 %     26.5 %     1.3 %     100.0 %
 
(a)   Represents core deposit, commercial loan and home equity loan products centrally managed outside of the four Community Banking regions.
Key’s National Banking group includes those corporate and consumer business units that operate nationally, within and beyond the 14-state branch network, as well as internationally. The specific products and services offered by the National Banking group are described in Note 4 (“Line of Business Results”), which begins on page 14.
The diversity of Key’s commercial real estate lending business based on industry type and location is shown in Figure 18 on page 67. The homebuilder loan portfolio within the National Banking group has been adversely affected by the downturn in the U.S. housing market. As a result of deteriorating market conditions in the residential properties segment of Key’s commercial real estate construction portfolio, principally in Florida and southern California, Key has experienced a significant increase in the level of its nonperforming assets since mid-2007 and has taken aggressive steps to reduce its exposure in this segment of its loan portfolio. As previously reported, during the fourth quarter of 2007, Key announced its decision to cease conducting business with nonrelationship homebuilders outside of its 14-state Community Banking footprint and, during the second quarter of 2008, initiated a process to further reduce its exposure through the planned sale of certain loans. As a result of these actions, Key has reduced the outstanding balances in the residential properties segment of its commercial real estate loan portfolio by $1.3 billion, or 34%, over the past twelve months, with the majority of the reduction coming from the weakest part of the portfolio. Additional information about the planned loan sales is included in the “Credit risk management” section, which begins on page 86.
In recent quarters, results for the National Banking group have also been affected adversely by volatility in the capital markets, leading to declines in the market values at which certain assets (primarily commercial real estate loans and securities held for sale or trading) are recorded. Results for the third quarter of 2008 include $33 million of after-tax derivative-related charges recorded as a result of market disruption caused by the failure of Lehman Brothers, and $19 million of realized and unrealized after-tax losses from the residential properties segment of the construction loan portfolio.
During the third quarter of 2008, the banking industry, including Key, continued to experience commercial and industrial loan growth, due in part to increased reliance by borrowers on commercial lines of credit in response to the challenging economic environment.

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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 critical; not only are they necessary to comply with U.S. generally accepted accounting principles (“GAAP”), they also reflect management’s view of the appropriate way 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 65 of Key’s 2007 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.
Management relies heavily on the use of judgment, assumptions and estimates to make a number of core decisions, including accounting for the allowance for loan losses; loan securitizations; contingent liabilities, guarantees and income taxes; derivatives and related hedging activities; and assets and liabilities that involve valuation methodologies. A brief discussion of each of these areas appears on pages 17 through 19 of Key’s 2007 Annual Report to Shareholders. Information about Key’s goodwill impairment testing conducted as of June 30, 2008, and the review performed as of September 30, 2008, is included in Note 1 (“Basis of Presentation”) under the heading “Goodwill and Other Intangible Assets” on page 7.
Effective January 1, 2008, Key adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In the absence of quoted market prices, management determines the fair value of Key’s assets and liabilities using internally-developed models which are based on management’s judgment, assumptions and estimates regarding credit quality, liquidity, interest rates and other relevant inputs. Key’s adoption of this accounting guidance and the process used in determining fair values are more fully described in Note 1 (“Basis of Presentation”) under the heading “Fair Value Measurements” on page 8 and Note 15 (“Fair Value Measurements”), which begins on page 35.
At September 30, 2008, $11.8 billion, or 12%, of Key’s total assets were measured at fair value on a recurring basis. Approximately 97% of these assets were classified as Level 1 or Level 2 within the fair value hierarchy. At September 30, 2008, $777 million, or 1%, of Key’s total liabilities were measured at fair value on a recurring basis. Substantially all of these liabilities were classified as Level 1 or Level 2.
At September 30, 2008, $622 million, or 1%, of Key’s total assets were measured at fair value on a nonrecurring basis. Approximately 1% of these assets were classified as Level 1 or Level 2. At September 30, 2008, there were no liabilities measured at fair value on a nonrecurring basis.
Highlights of Key’s Performance
Financial performance
For the third quarter of 2008, Key recorded a loss from continuing operations of $36 million, or $.10 per common share. This compares to income from continuing operations of $224 million, or $.57 per diluted common share, for the third quarter of 2007, and a loss from continuing operations of $1.126 billion, or $2.70 per common share, for the second quarter of 2008.
Key’s results for 2008 include additional charges associated with certain leveraged lease financing transactions being challenged by the Internal Revenue Service (“IRS”). Third and second quarter results include after-tax charges of $30 million, or $.06 per common share, and $1.011 billion, or $2.43 per common share, respectively, resulting from a previously announced adverse federal court decision on the tax treatment of a Service Contract Lease transaction.

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During the first quarter of 2008, Key increased its tax reserves for certain lease in, lease out (“LILO”) transactions and recalculated its lease income in accordance with prescribed accounting standards, resulting in after-tax charges of $38 million, or $.10 per common share.
For the first nine months of 2008, Key reported a loss from continuing operations of $944 million, or $2.19 per common share. Adjusting for the lease financing charges, Key had income from continuing operations of $135 million, or $.30 per diluted common share, compared to $919 million, or $2.31 per diluted common share, for the same period last year.
Key reported a net loss of $36 million, or $.10 per common share, for the third quarter of 2008, compared to net income of $210 million, or $.54 per diluted common share, for the third quarter of 2007, and a net loss of $1.126 billion, or $2.70 per common share, for the second quarter of 2008. For the first nine months of 2008, Key reported a net loss of $944 million, or $2.19 per common share, compared to net income of $894 million, or $2.25 per diluted common share, for the same period last year.
Figure 2 shows Key’s continuing and discontinued operating results and related performance ratios for comparative quarters and the nine-month periods ended September 30, 2008 and 2007.
Figure 2. Results of Operations
                                         
    Three months ended     Nine months ended  
dollars in millions, except per share amounts   9-30-08     6-30-08     9-30-07     9-30-08     9-30-07  
 
SUMMARY OF OPERATIONS
                                       
(Loss) income from continuing operations
  $ (36 )   $ (1,126 )   $ 224     $ (944 )   $ 919  
Loss from discontinued operations, net of taxes a
                (14 )           (25 )
 
Net (loss) income
  $ (36 )   $ (1,126 )   $ 210     $ (944 )   $ 894  
 
                             
 
                                       
Net (loss) income applicable to common shares
  $ (48 )   $ (1,126 )   $ 210     $ (956 )   $ 894  
 
PER COMMON SHARE — ASSUMING DILUTION
                                   
(Loss) income from continuing operations
  $ (.10 )   $ (2.70 )   $ .57     $ (2.19 )   $ 2.31  
Loss from discontinued operations a
                (.03 )           (.06 )
 
Net (loss) income
  $ (.10 )   $ (2.70 )   $ .54     $ (2.19 )   $ 2.25  
 
                             
 
PERFORMANCE RATIOS
                                       
From continuing operations:
                                       
Return on average total assets
    (.14 )%     (4.38 )%     .93 %     (1.22 )%     1.31 %
Return on average common equity
    (2.36 )     (53.35 )     11.50       (15.32 )     16.03  
Return on average total equity
    (1.64 )     (52.56 )     11.50       (14.66 )     16.03  
From consolidated operations:
                                       
Return on average total assets
    (.14 )%     (4.38 )%     .88 %     (1.22 )%     1.28 %
Return on average common equity
    (2.36 )     (53.35 )     10.79       (15.32 )     15.59  
Return on average total equity
    (1.64 )     (52.56 )     10.79       (14.66 )     15.59  
 
(a)   Key sold the subprime 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 continuation of a difficult economic environment and the resulting increase in Key’s allowance for loan losses contributed to the loss recorded for the third quarter of 2008. The current quarter provision for loan losses exceeded net loan charge-offs by $134 million and increased Key’s allowance for loan losses to $1.554 billion, or 2.03% of period-end loans. Additionally, third quarter results were adversely impacted by $33 million of after-tax losses on derivative contracts that resulted from market disruption caused by the failure of Lehman Brothers, and $19 million of realized and unrealized after-tax losses from the residential properties segment of the construction loan portfolio. As previously reported, Key has taken action to reduce its exposure to the residential properties segment of its commercial real estate construction loan portfolio through the planned sale of certain loans. As a result of these efforts and the December 2007 decision to cease conducting business with nonrelationship homebuilders outside of its 14-state Community Banking footprint, Key’s total residential property exposure in commercial real estate, including loans held for sale, has been reduced by $1.3 billion, or 34%, over the past twelve months, with the majority of the reduction coming from the weakest part of the portfolio. Additional information pertaining to the status of these loan sales is presented in the section entitled “Credit risk management,” which begins on page 86.

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Through this difficult credit cycle, management has continued to focus on Key’s relationship business model, maintain Key’s strong capital position and carefully manage expenses to ensure the company’s readiness to respond to business opportunities as they emerge. During the third quarter, Key continued to take decisive steps to exit low-return, indirect businesses, consistent with the company’s strategy of focusing its capital and resources on its best relationship customers. Key is in the process of exiting direct and indirect retail and floor-plan lending for marine and recreational vehicle products, will limit new student loans to those backed by government guarantee and will cease conducting business with homebuilders outside of its 14-state Community Banking footprint. These actions are the most recent in a series of actions taken over several years that have seen the company exit subprime mortgage and automobile financing and broker-originated home equity lending, and dispose of a segment of its residential homebuilder portfolio.
As previously reported, Key took aggressive steps during the second quarter of 2008 to further strengthen its capital position by raising additional capital through the issuance of preferred stock and common shares and by reducing the dividend on its common shares by 50% to an annualized dividend of $.75 per share. At September 30, 2008, Key had Tier 1 and total capital ratios of 8.55% and 12.40%, respectively, both of which exceed the “well-capitalized” standard for banks established by the banking regulators.
Despite the challenging economic environment, the Community Banking group continues to perform solidly, with higher revenue and deposit growth across the entire branch network. Management believes that Key’s continued focus on building a relationship-based, customer-focused business model, along with the actions discussed above will serve Key well as the economy ultimately recovers.
Further, Key has elected to reduce uncertainty surrounding its previously disclosed leveraged lease tax issue with the IRS. While management continues to believe Key’s initial tax position was correct, it would take years of effort and expense to resolve this matter through litigation. Accordingly, Key has elected to participate in the IRS’ global settlement initiative, which is essentially an offer by the federal tax authorities to resolve all such disputed cases. Key expects that the definitive settlement documents will be executed as soon as the fourth quarter and that Key should realize an after-tax recovery of between $75 million and $100 million for previously accrued interest on disputed tax balances. Additional information pertaining to the status of leveraged lease tax issue and Key’s opt-in to the IRS’ global settlement initiative is included in Note 12 (“Income Taxes”), which begins on page 27.
Shown in Figure 3 below are significant items that affect the comparability of Key’s financial performance for the periods presented.
Figure 3. Significant Items Affecting the Comparability of Earnings
                                                                                 
    Three months ended     Nine months ended  
    September 30, 2008     June 30, 2008     September 30, 2007     September 30, 2008     September 30, 2007  
    Pre-tax     After-tax     Pre-tax     After-tax     Pre-tax     After-tax     Pre-tax     After-tax     Pre-tax     After-tax  
in millions   Amount     Amount     Amount     Amount     Amount     Amount     Amount     Amount     Amount     Amount  
 
Charges related to leveraged lease tax litigation
        $ (30 )   $ (359 )   $ (1,011 )               $ (362 )   $ (1,079 )            
Provision for loan losses in excess of net
charge-offs
  $ (134 )     (83 )     (123 )     (77 )   $ (10 )   $ (6 )     (323 )     (202 )   $ (10 )   $ (6 )
Realized and unrealized (losses) gains on loan and securities portfolios held for sale or trading
    (94 ) a     (59 ) a     62       39       (77 )     (49 )     (160 ) a     (100 ) a     (4 )     (3 )
Severance and other exit costs
    (19 )     (14 )     (8 )     (5 )     (4 )     (3 )     (33 )     (22 )     (10 )     (6 )
Net (losses) gains from principal investing
    (24 )     (15 )     (14 )     (8 )     9       6       (29 )     (18 )     128       80  
Honsador litigation reserve
    23       14                               23       14       (42 )     (26 )
Gain from redemption of Visa Inc. shares
                                        165       103              
McDonald Investments branch network  b
                            (5 )     (3 )                 146       92  
Gain related to MasterCard Incorporated shares
                            27       17                   67       42  
Gain from settlement of automobile residual value insurance litigation
                                                    26       17  
 
(a)   Includes $54 million ($33 million after tax) of derivative-related charges recorded as a result of market disruption caused by the failure of Lehman Brothers and $31 million ($19 million after tax) of realized and unrealized losses from the residential properties segment of the construction loan portfolio.
 
(b)   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.

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Events leading to the recognition of the items presented in Figure 3, as well as other factors that contributed to the changes in Key’s revenue and expense components from those reported for the third quarter of 2007, are reviewed in detail throughout the remainder of the Management’s Discussion and Analysis section.
Key’s financial performance for each of the past five quarters and for the nine-month periods ended September 30, 2008 and 2007, is summarized in Figure 4.
Figure 4. Selected Financial Data
                                                         
                                            Nine months ended  
    2008     2007     September 30,  
dollars in millions, except per share amounts   Third     Second     First     Fourth     Third     2008     2007  
 
FOR THE PERIOD
                                                       
Interest income
  $ 1,232     $ 880     $ 1,354     $ 1,447     $ 1,434     $ 3,466     $ 4,197  
Interest expense
    533       522       641       737       740       1,696       2,138  
Net interest income
    699  a     358  a     713  a     710       694       1,770  a     2,059  
Provision for loan losses
    407       647       187       363       69       1,241       166  
Noninterest income
    388       555       528       488       438       1,471       1,741  
Noninterest expense
    762       781       732       896       753       2,275       2,352  
(Loss) income from continuing operations before income taxes
    (82 )     (515 )     322       (61 )     310       (275 )     1,282  
(Loss) income from continuing operations
    (36 )     (1,126 )     218       22       224       (944 )     919  
Income (loss) from discontinued operations, net of taxes
                      3       (14 )           (25 )
Net (loss) income
    (36 ) a     (1,126 ) a     218  a     25       210       (944 ) a     894  
Net (loss) income applicable to common shares
    (48 )     (1,126 )     218       25       210       (956 )     894  
 
PER COMMON SHARE
                                                       
(Loss) income from continuing operations
  $ (.10 )   $ (2.70 )   $ .55     $ .06     $ .58     $ (2.19 )   $ 2.34  
Income (loss) from discontinued operations
                      .01       (.03 )           (.06 )
Net (loss) income
    (.10 )     (2.70 )     .55       .06       .54       (2.19 )     2.28  
 
(Loss) income from continuing operations — assuming dilution
    (.10 )     (2.70 )     .54       .06       .57       (2.19 )     2.31  
Income (loss) from discontinued operations — assuming dilution
                      .01       (.03 )           (.06 )
Net (loss) income — assuming dilution
    (.10 ) a     (2.70 ) a     .54  a     .06       .54       (2.19 ) a     2.25  
 
Cash dividends paid
    .1875       .375       .375       .365       .365       .9375       1.095  
Book value at period end
    16.16       16.59       21.48       19.92       20.12       16.16       20.12  
Tangible book value at period end
    12.66       13.00       17.07       16.39       16.76       12.66       16.76  
Market price:
                                                       
High
    15.25       26.12       27.23       34.05       37.09       27.23       39.90  
Low
    7.93       10.00       19.00       21.04       31.38       7.93       31.38  
Close
    11.94       10.98       21.95       23.45       32.33       11.94       32.33  
Weighted-average common shares outstanding (000)
    491,179       416,629       399,121       388,940       389,319       435,846       393,048  
Weighted-average common shares
and potential common shares
outstanding (000)
    491,179       416,629       399,769       389,911       393,164       435,846       397,816  
 
AT PERIOD END
                                                       
Loans
  $ 76,705     $ 75,855     $ 76,444     $ 70,823     $ 68,999     $ 76,705     $ 68,999  
Earning assets
    90,257       89,893       89,719       86,557       84,838       90,257       84,873  
Total assets
    101,290       101,544       101,492       98,228       96,137       101,290       97,366  
Deposits
    64,678       64,396       64,702       63,099       63,714       64,678       63,714  
Long-term debt
    15,597       15,106       14,337       11,957       11,549       15,597       11,549  
Common shareholders’ equity
    7,993       8,056       8,592       7,746       7,820       7,993       7,820  
Total shareholders’ equity
    8,651       8,706       8,592       7,746       7,820       8,651       7,820  
 
PERFORMANCE RATIOS
                                                       
From continuing operations:
                                                       
Return on average total assets
    (.14 )%     (4.38 )%     .85 %     .09 %     .93 %     (1.22 )%     1.31 %
Return on average common equity
    (2.36 )     (53.35 )     10.38       1.11       11.50       (15.32 )     16.03  
Return on average total equity
    (1.64 )     (52.56 )     10.38       1.11       11.50       (14.66 )     16.03  
Net interest margin (taxable equivalent)
    3.13       (.44 )     3.14       3.48       3.40       1.95       3.46  
From consolidated operations:
                                                       
Return on average total assets
    (.14 )% a     (4.38 )% a     .85 % a     .10 %     .88 %     (1.22 )% a     1.28 %
Return on average common equity
    (2.36 ) a     (53.35 ) a     10.38  a     1.26       10.79       (15.32 ) a     15.59  
Return on average total equity
    (1.64 ) a     (52.56 ) a     10.38  a     1.26       10.79       (14.66 ) a     15.59  
Net interest margin (taxable equivalent)
    3.13  a     (.44 ) a     3.14  a     3.48       3.40       1.95  a     3.46  
 
CAPITAL RATIOS AT PERIOD END
                                                       
Equity to assets
    8.54 %     8.57 %     8.47 %     7.89 %     8.13 %     8.54 %     8.13 %
Tangible equity to tangible assets
    6.95       6.98       6.85       6.58       6.87       6.95       6.87  
Tier 1 risk-based capital
    8.55       8.53       8.33       7.44       7.94       8.48       7.94  
Total risk-based capital
    12.40       12.41       12.34       11.38       11.76       12.31       11.76  
Leverage
    9.28       9.34       9.15       8.39       8.96       9.46       8.96  
 
TRUST AND BROKERAGE ASSETS
                                                     
Assets under management
  $ 76,676     $ 80,998     $ 80,453     $ 85,442     $ 88,100     $ 76,676     $ 88,100  
Nonmanaged and brokerage assets
    27,187       29,905       30,532       33,918       33,273       27,187       33,273  
 
OTHER DATA
                                                       
Average full-time equivalent employees
    18,291       18,164       18,426       18,500       18,567       18,294       19,081  
Branches
    986       985       985       955       954       986       954  
 
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 12, contains specific information about the acquisitions and divestitures that Key completed during 2007 and the first nine months of 2008 to help in understanding how those transactions may have impacted Key’s financial condition and results of operations.
(a)   See Figure 5, which shows certain earnings data and performance ratios, excluding charges related to the tax treatment of certain leveraged lease financing transactions disallowed by the IRS. Figure 5 reconciles certain GAAP performance measures to the corresponding non-GAAP measures and provides a basis for period-to-period comparisons.

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As a result of an adverse federal court decision on Key’s tax treatment of a Service Contract Lease transaction entered into by AWG Leasing Trust, in which Key is a partner, Key recorded after-tax charges of $30 million, or $.06 per common share, during the third quarter of 2008, and $1.011 billion, or $2.43 per common share, during the second quarter of 2008. Additionally, during the first quarter of 2008, Key increased its tax reserves for certain LILO transactions and recalculated its lease income in accordance with prescribed accounting standards, resulting in after-tax charges of $38 million, or $.10 per common share. The table below presents certain earnings data and performance ratios, excluding these charges (non-GAAP), reconciles the GAAP performance measures to the corresponding non-GAAP measures and provides a basis for period-to-period comparisons. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied and are not audited. Non-GAAP financial measures should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.
Figure 5. GAAP to Non-GAAP Reconciliations
                                 
    Three months ended     Nine months ended  
dollars in millions, except per share amounts   9-30-08     6-30-08     3-31-08     9-30-08  
 
NET INCOME
                               
Net (loss) income (GAAP)
  $ (36 )   $ (1,126 )   $ 218     $ (944 )
Charges related to leveraged lease tax litigation, after tax
    30       1,011       38       1,079  
 
Net (loss) income, excluding charges related to leveraged lease tax litigation (non-GAAP)
  $ (6 )   $ (115 )   $ 256     $ 135  
 
                       
 
Net (loss) income applicable to common shares (GAAP)
  $ (48 )   $ (1,126 )   $ 218     $ (956 )
 
                               
PER COMMON SHARE
                               
Net (loss) income — assuming dilution (GAAP)
  $ (.10 )   $ (2.70 )   $ .54     $ (2.19 )
Net (loss) income, excluding charges related to leveraged lease tax litigation — assuming dilution (non-GAAP)
    (.04 )     (.28 )     .64       .30  
 
                               
PERFORMANCE RATIOS
                               
Return on average total assets: a
                               
Average total assets
  $ 103,156     $ 103,290     $ 103,356     $ 103,267  
 
                               
Return on average total assets (GAAP)
    (.14 )%     (4.38 )%     .85 %     (1.22 )%
Return on average total assets, excluding charges related to leveraged lease tax litigation (non-GAAP)
    (.02 )     (.45 )     1.00       .17  
 
                               
Return on average common equity: a
                               
Average common equity
  $ 8,077     $ 8,489     $ 8,445     $ 8,336  
 
                               
Return on average common equity (GAAP)
    (2.36 )%     (53.35 )%     10.38 %     (15.32 )%
Return on average common equity, excluding charges related to leveraged lease tax litigation (non-GAAP)
    (.89 )     (5.45 )     12.19       1.97  
 
                               
Return on average total equity: a
                               
Average total equity
  $ 8,734     $ 8,617     $ 8,445     $ 8,599  
 
                               
Return on average total equity (GAAP)
    (1.64 )%     (52.56 )%     10.38 %     (14.66 )%
Return on average total equity, excluding charges related to leveraged lease tax litigation (non-GAAP)
    (.27 )     (5.37 )     12.19       2.10  
 
                               
NET INTEREST INCOME AND MARGIN
                               
Net interest income:
                               
Net interest income (GAAP)
  $ 699     $ 358     $ 713     $ 1,770  
Charges related to leveraged lease tax litigation, pre-tax
          359       3       362  
 
Net interest income, excluding charges related to leveraged lease tax litigation (non-GAAP)
  $ 699     $ 717     $ 716     $ 2,132  
 
                       
 
 
                               
Net interest income/margin (TE):
                               
Net interest income (loss) (TE) (as reported)
  $ 705     $ (100 )   $ 704     $ 1,309  
Charges related to leveraged lease tax litigation, pre-tax (TE)
          838       34       872  
 
Net interest income, excluding charges related to leveraged lease tax litigation (TE) (adjusted basis)
  $ 705     $ 738     $ 738     $ 2,181  
 
                       
 
 
                               
Net interest margin (TE) (as reported) a
    3.13 %     (.44 )%     3.14 %     1.95 %
Impact of charges related to leveraged lease tax litigation,
pre-tax (TE) a
          3.76       .15       1.30  
 
Net interest margin, excluding charges related to leveraged lease tax litigation (TE) (adjusted basis) a
    3.13 %     3.32 %     3.29 %     3.25 %
 
                       
 
(a)   Income statement amount has been annualized in calculation of percentage.
 
TE = Taxable Equivalent
 
GAAP = U.S. generally accepted accounting principles

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Financial outlook
Although difficult to project in this turbulent economy, considering current and anticipated conditions in the financial markets, and the continuation of competitive pricing for deposits, management expects that, in the fourth quarter of 2008, Key will experience:
¨   a taxable-equivalent net interest margin in the range of 3.00% to 3.10%;
 
¨   a low- to mid-single digit percentage increase in loans;
 
¨   a low- to mid-single digit percentage increase in deposits;
 
¨   net loan charge-offs in the range of 1.40% to 1.70% of average loans; and
 
¨   an infusion of $2.5 billion of Tier 1 capital from Key’s participation in the U.S. Treasury’s TARP Capital Purchase Program.
On October 24, 2008, the U.S. Treasury informed KeyCorp that it had received preliminary approval to participate in the U.S. Treasury’s TARP Capital Purchase Program. Under the TARP Capital Purchase Program, the U.S. Treasury would purchase $2.5 billion of TARP preferred stock and warrants to purchase common shares of KeyCorp. KeyCorp anticipates receipt of the additional capital by December 31, 2008. The TARP Capital Purchase Program was initiated by the U.S. Treasury under authority provided in the\ EESA in order to restore liquidity and stability to the U.S. financial system. Additional information pertaining to the EESA and the TARP Capital Purchase Program is presented in the “Capital” discussion under the heading “Emergency Economic Stabilization Act of 2008” on page 77.
Strategic developments
Management initiated a number of specific actions during 2008 and 2007 to support Key’s corporate strategy, which is described under the heading “Corporate Strategy” on page 16 of Key’s 2007 Annual Report to Shareholders.
¨   During the third quarter of 2008, Key decided to exit direct and indirect retail and floor-plan lending for marine and recreational vehicle products and to limit new student loans to those backed by government guarantee. Key also determined that it will cease conducting business with homebuilders within its 14-state Community Banking footprint.
 
¨   On January 1, 2008, Key acquired U.S.B. Holding Co., Inc., the holding company for Union State Bank, a 31-branch state-chartered commercial bank headquartered in Orangeburg, New York. The acquisition doubles Key’s branch presence in the attractive Lower Hudson Valley area. Assets and deposits acquired in this transaction were assigned to both the Community Banking and National Banking groups.
 
¨   On December 20, 2007, Key announced its decision to exit dealer-originated home improvement lending activities, which involve prime loans but are largely out-of-footprint. Key also announced that it will cease offering Payroll Online services, which are not of sufficient size to provide economies of scale to compete profitably. Additionally, Key has moved to cease conducting business with nonrelationship homebuilders outside of its 14-state Community Banking footprint.
 
¨   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 combination of the payment plan systems and technology in place at Tuition Management Systems and the array of payment plan products offered by Key’s Consumer Finance line of business created one of the largest education payment plan providers in the nation.

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¨   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 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 the registered broker-dealer through which its corporate and institutional investment banking and securities businesses operate to KeyBanc Capital Markets Inc.

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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 14. 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 6 summarizes the contribution made by each major business group to Key’s taxable-equivalent revenue and (loss) income from continuing operations for the three- and nine-month periods ended September 30, 2008 and 2007. Key’s line of business results for each of these periods reflect a new organizational structure that took effect January 1, 2008.
Figure 6. Major Business Groups — Taxable-Equivalent Revenue and (Loss) Income from Continuing Operations
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2008     2007     Amount     Percent     2008     2007     Amount     Percent  
 
REVENUE FROM CONTINUING OPERATIONS (TE)
                                                               
Community Banking a
  $ 658     $ 629     $ 29       4.6 %   $ 1,949     $ 2,067     $ (118 )     (5.7 )%
National Banking b
    482       507       (25 )     (4.9 )     790       1,719       (929 )     (54.0 )
Other Segments c
    (17 )     15       (32 )     N/M       (23 )     97       (120 )     N/M  
 
Total Segments
    1,123       1,151       (28 )     (2.4 )     2,716       3,883       (1,167 )     (30.1 )
Reconciling Items d
    (30 )     (1 )     (29 )     N/M       64       (24 )     88       N/M  
 
Total
  $ 1,093     $ 1,150     $ (57 )     (5.0 )%   $ 2,780     $ 3,859     $ (1,079 )     (28.0 )%
 
                                               
 
                                                               
(LOSS) INCOME FROM CONTINUING OPERATIONS
                                                               
Community Banking a
  $ 98     $ 134     $ (36 )     (26.9 )%   $ 318     $ 442     $ (124 )     (28.1 )%
National Banking b
    (133 )     70       (203 )     N/M       (829 )     384       (1,213 )     N/M  
Other Segments c
    9       16       (7 )     (43.8 )     17       63       (46 )     (73.0 )
 
Total Segments
    (26 )     220       (246 )     N/M       (494 )     889       (1,383 )     N/M  
Reconciling Items d
    (10 )     4       (14 )     N/M       (450 )     30       (480 )     N/M  
 
Total
  $ (36 )   $ 224     $ (260 )     N/M     $ (944 )   $ 919     $ (1,863 )     N/M  
 
                                               
 
(a)   Community Banking’s results for the first quarter 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 12, for more information pertaining to this transaction.
 
(b)   National Banking’s results for the third quarter of 2008 include $54 million ($33 million after tax) of derivative-related charges recorded as a result of market disruption caused by the failure of Lehman Brothers and $31 million ($19 million after tax) of realized and unrealized losses from the residential properties segment of the construction loan portfolio. During the second quarter of 2008, National Banking’s taxable-equivalent net interest income and net income were reduced by $838 million and $536 million, respectively, as a result of an adverse federal court decision on the tax treatment of a Service Contract Lease transaction. During the first quarter of 2008, National Banking increased its tax reserves for certain LILO transactions and recalculated its lease income in accordance with prescribed accounting standards. These actions reduced National Banking’s taxable-equivalent revenue by $34 million and its net income by $21 million in the first quarter. National Banking’s results for the first quarter of 2007 include a $26 million ($17 million after tax) gain from the settlement of the residual value insurance litigation.
 
(c)   Other Segments’ results for the third quarter of 2008 include a $23 million ($14 million after tax) credit, representing the reversal of the remaining reserve associated with the Honsador litigation, which was settled in September. Other Segments’ results for the second quarter of 2007 include a $26 million ($16 million after tax) charge for litigation. This charge and the litigation charge referred to in note (d) below comprise the initial $42 million reserve established in connection with the Honsador litigation. Other Segments’ results for the first quarter of 2007 include a $49 million ($31 million after tax) loss from the repositioning of the securities portfolio.
 
(d)   Reconciling Items for the third and second quarters of 2008 include charges of $30 million and $475 million, respectively, to income taxes for the interest cost associated with the leveraged lease tax litigation. Reconciling Items for the first quarter of 2008 include a $165 million ($103 million after tax) gain from the partial redemption of Key’s equity interest in Visa Inc. and a $17 million charge to income taxes for the interest cost associated with the increase to Key’s tax reserves for certain LILO transactions. Reconciling Items for the third and second quarters of 2007 include gains of $27 million ($17 million after tax) and $40 million ($25 million after tax), respectively, related to MasterCard Incorporated shares. During the second quarter of 2007, Reconciling Items include a $16 million ($10 million after tax) charge for litigation.
 
TE = Taxable Equivalent
 
N/M = Not Meaningful

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Community Banking summary of operations
As shown in Figure 7, Community Banking recorded net income of $98 million for the third quarter of 2008, compared to $134 million for the year-ago quarter. Increases in the provision for loan losses and noninterest expense were the primary causes of the decline, and more than offset an increase in net interest income.
Figure 7. Community Banking
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2008     2007     Amount     Percent     2008     2007     Amount     Percent  
 
SUMMARY OF OPERATIONS
                                                               
Net interest income (TE)
  $ 445     $ 412     $ 33       8.0 %   $ 1,307     $ 1,248     $ 59       4.7 %
Noninterest income
    213       217       (4 )     (1.8 )     642       819  a     (177 )     (21.6 )
 
Total revenue (TE)
    658       629       29       4.6       1,949       2,067       (118 )     (5.7 )
Provision for loan losses
    56       2       54       N/M       118       37       81       218.9  
Noninterest expense
    445       413       32       7.7       1,323       1,323              
 
Income before income taxes (TE)
    157       214       (57 )     (26.6 )     508       707       (199 )     (28.1 )
Allocated income taxes and TE adjustments
    59       80       (21 )     (26.3 )     190       265       (75 )     (28.3 )
 
Net income
  $ 98     $ 134     $ (36 )     (26.9 )%   $ 318     $ 442     $ (124 )     (28.1 )%
 
                                                   
 
                                                               
Percent of consolidated income from continuing operations
    N/M       60 %     N/A       N/A       N/M       48 %     N/A       N/A  
 
                                                               
AVERAGE BALANCES
                                                               
Loans and leases
  $ 28,872     $ 26,944     $ 1,928       7.2 %   $ 28,483     $ 26,659     $ 1,824       6.8 %
Total assets
    31,934       29,708       2,226       7.5       31,418       29,445       1,973       6.7  
Deposits
    50,384       46,729       3,655       7.8       50,035       46,459       3,576       7.7  
 
                                                               
Assets under management at period end
  $ 18,278     $ 21,903     $ (3,625 )     (16.6 )%   $ 18,278     $ 21,903     $ (3,625 )     (16.6 )%
 
(a)   Community Banking’s results for the first quarter 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 12, for more information pertaining to this transaction.
 
TE = Taxable Equivalent
 
N/M = Not Meaningful
 
N/A = Not Applicable
Additional Community Banking Data
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2008     2007     Amount     Percent     2008     2007     Amount     Percent  
 
AVERAGE DEPOSITS OUTSTANDING
                                                               
NOW and money market deposit accounts
  $ 19,507     $ 20,307     $ (800 )     (3.9 )%   $ 19,674     $ 19,633     $ 41       .2 %
Savings deposits
    1,752       1,569       183       11.7       1,770       1,602       168       10.5  
Certificates of deposits ($100,000 or more)
    6,875       4,566       2,309       50.6       6,663       4,609       2,054       44.6  
Other time deposits
    13,103       11,485       1,618       14.1       12,869       11,856       1,013       8.5  
Deposits in foreign office
    1,193       1,128       65       5.8       1,252       1,044       208       19.9  
Noninterest-bearing deposits
    7,954       7,674       280       3.6       7,807       7,715       92       1.2  
 
Total deposits
  $ 50,384     $ 46,729     $ 3,655       7.8 %   $ 50,035     $ 46,459     $ 3,576       7.7 %
 
                                                   
 
HOME EQUITY LOANS
               
Average balance
  $ 9,887     $ 9,690  
Weighted-average loan-to-value ratio
    70 %     70 %
Percent first lien positions
    54       58  
   
OTHER DATA
               
Branches
    986       954  
Automated teller machines
    1,479       1,439  
   
Taxable-equivalent net interest income rose by $33 million, or 8%, from the third quarter of 2007. The increase was attributable to a $1.9 billion, or 7%, rise in average earning assets, due largely to growth in the commercial loan portfolio, and a $3.7 billion, or 8%, increase in average deposits. Both loans and deposits experienced organic growth and benefited from the January 1, 2008, acquisition of U.S.B. Holding Co., Inc. described on page 54.
The provision for loan losses rose by $54 million compared to the third quarter of 2007, reflecting a $51 million increase in net loan charge-offs, almost half of which was attributable to two specific commercial loans.

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Noninterest expense rose by $32 million, or 8%, from the year-ago quarter as a result of increases in personnel expense, marketing expense, professional fees, costs associated with other real estate owned, and smaller increases in a variety of other expense components. Overall, the increase in noninterest expense was largely attributable to initiatives undertaken with regard to branch modernization, deposit growth and the acquisition of U.S.B. Holding Co., Inc.
On January 1, 2008, Key acquired U.S.B. Holding Co., Inc., the holding company for Union State Bank, a 31-branch state-chartered commercial bank headquartered in Orangeburg, New York. The acquisition doubles Key’s branch presence in the attractive Lower Hudson Valley area. Assets and deposits acquired in this transaction were assigned to both the Community Banking and National Banking groups.
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 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.
National Banking summary of continuing operations
As shown in Figure 8, National Banking recorded a loss of $133 million from continuing operations for the third quarter of 2008, compared to income of $70 million from continuing operations for the same period last year. A substantially higher provision for loan losses, lower net interest income and an increase in noninterest expense were offset in part by growth in noninterest income.
Figure 8. National Banking
                                                                 
    Three months ended                     Nine months ended        
    September 30,     Change     September 30,     Change  
dollars in millions   2008     2007     Amount     Percent     2008     2007     Amount     Percent  
 
SUMMARY OF OPERATIONS
                                                               
Net interest (loss) income (TE)
  $ 322  a   $ 355     $ (33 )     (9.3 )   $ 184  a   $ 1,035     $ (851 )     (82.2 )%
Noninterest income
    160       152       8       5.3 %     606       684  a     (78 )     (11.4 )
 
Total revenue (TE)
    482       507       (25 )     (4.9 )     790       1,719       (929 )     (54.0 )
Provision for loan losses
    350       69       281       407.2       1,128       131       997       761.1  
Noninterest expense
    342       327       15       4.6       986       974       12       1.2  
 
(Loss) income from continuing operations before income taxes (TE)
    (210 )     111       (321 )     N/M       (1,324 )     614       (1,938 )     N/M  
Allocated income taxes and TE adjustments
    (77 )     41       (118 )     N/M       (495 )     230       (725 )     N/M  
 
(Loss) income from continuing operations
    (133 )     70       (203 )     N/M       (829 )     384       (1,213 )     N/M  
Loss from discontinued operations, net of taxes
          (14 )     14       100.0             (25 )     25       100.0  
 
Net (loss) income
  $ (133 )   $ 56     $ (189 )     N/M     $ (829 )   $ 359     $ (1,188 )     N/M  
 
                                                   
 
                                                               
Percent of consolidated income from continuing operations
    N/M       31 %     N/A       N/A       N/M       42 %     N/A       N/A  
 
                                                               
AVERAGE BALANCES FROM CONTINUING OPERATIONS
                                                               
Loans and leases
  $ 47,075     $ 40,279     $ 6,796       16.9 %   $ 46,374     $ 39,487     $ 6,887       17.4 %
Loans held for sale
    1,651       4,692       (3,041 )     (64.8 )     2,618       4,331       (1,713 )     (39.6 )
Total assets
    56,183       50,961       5,222       10.2       56,254       49,666       6,588       13.3  
Deposits
    12,439       12,631       (192 )     (1.5 )     12,205       12,008       197       1.6  
 
                                                               
Assets under management at period end
  $ 58,398     $ 66,197     $ (7,799 )     (11.8) %   $ 58,398     $ 66,197     $ (7,799 )     (11.8) %
 
(a)   National Banking’s results for the third quarter of 2008 include $54 million ($33 million after tax) of derivative-related charges recorded as a result of market disruption caused by the failure of Lehman Brothers and $31 million ($19 million after tax) of realized and unrealized losses from the residential properties segment of the construction loan portfolio. During the second quarter of 2008, National Banking’s taxable-equivalent net interest income and net income were reduced by $838 million and $536 million, respectively, as a result of an adverse federal court decision on the tax treatment of a Service Contract Lease transaction. During the first quarter of 2008, National Banking increased its tax reserves for certain LILO transactions and recalculated its lease income in accordance with prescribed accounting standards. These actions reduced National Banking’s taxable-equivalent revenue by $34 million and its net income by $21 million in the first quarter. National Banking’s results for the first quarter of 2007 include a $26 million ($17 million after tax) gain from the settlement of the residual value insurance litigation.
 
TE = Taxable Equivalent
 
N/M = Not Meaningful
 
N/A = Not Applicable

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Taxable-equivalent net interest income decreased by $33 million, or 9%, from the third quarter of 2007 as a result of tighter loan and deposit spreads caused by competitive pricing, and a higher level of nonperforming assets. Also contributing to the decrease was the prospective reduction in net interest income caused by the second quarter 2008 recalculation of income previously recognized on all leveraged leases being contested by the IRS. Average loans and leases grew by $6.8 billion, or 17%, while the level of average deposits was down slightly from the year-ago quarter. Contributing to the loan growth was the March 31, 2008, transfer of $3.3 billion of education loans from loans held for sale to the loan portfolio.
Excluding $54 million of derivative-related charges recorded in the current quarter as a result of market disruption caused by the failure of Lehman Brothers, noninterest income rose by $62 million, or 41%, from the third quarter of 2007. The improvement reflected a $15 million increase in income from trust and investment services, a $23 million reduction in net losses from loan sales and write-downs, and a $15 million decrease in losses attributable to changes in the fair values of certain real estate related investments held by the Private Equity unit within the Real Estate Capital and Corporate Banking Services line of business. Noninterest income also benefited from an increase in fee income generated from tuition payment plan processing.
The provision for loan losses rose by $281 million, due primarily to higher levels of net loan charge-offs from the commercial, commercial real estate and education loan portfolios. National Banking’s provision for loan losses for the third quarter of 2008 exceeded its net loan charge-offs by $147 million, as the company continued to build reserves.
Noninterest expense increased by $15 million, or 5%, from the third quarter of 2007, reflecting $10 million of additional expense attributable to severance and other costs recorded during the current quarter in connection with Key’s decision to exit direct and indirect retail and floor-plan lending for marine and recreational vehicle products.
During the third quarter of 2008, Key decided to exit direct and indirect retail and floor-plan lending for marine and recreational vehicle products and to limit new student loans to those backed by government guarantee. Additionally, Key has determined that it will cease conducting business with homebuilders within its 14-state Community Banking footprint. In December 2007, Key had previously announced its decision to cease lending to out-of-footprint homebuilders. These strategic actions are consistent with those taken over the past several years to exit low-return nonrelationship business.
Other Segments
Other segments consist of Corporate Treasury and Key’s Principal Investing unit. These segments generated net income of $9 million for the third quarter of 2008, compared to $16 million for the same period last year. These results reflect less favorable results from principal investing in the current year.

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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 9, which spans pages 58 and 59, 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. 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. This figure also presents a reconciliation of taxable-equivalent net interest income for each of the past five quarters to net interest income reported in accordance with GAAP.
Key’s taxable-equivalent net interest income was $705 million for the third quarter of 2008, compared to $712 million for the year-ago quarter. Average earning assets rose by $6.6 billion, or 8%, due primarily to growth in commercial loans and the January 1 acquisition of U.S.B. Holding Co., Inc., which added approximately $1.5 billion to Key’s loan portfolio. The net interest margin for the current quarter declined to 3.13% from 3.40% for the third quarter of 2007. Approximately 13 basis points of the reduction was attributable to the prospective reduction in net interest income caused by the second quarter 2008 recalculation of income previously recognized on all leveraged leases being contested by the IRS. Also contributing to the lower net interest margin were tighter loan and deposit spreads caused by competitive pricing, and a higher level of nonperforming assets.
As previously reported, Key’s taxable-equivalent net interest income for the second quarter of 2008 was reduced significantly as a result of an adverse federal court decision on the company’s tax treatment of a Service Contract Lease transaction entered into by AWG Leasing Trust, in which Key is a partner. In accordance with the accounting guidance provided under Financial Accounting Standards Board (“FASB”) 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,” Key recalculated the lease income recognized from inception for all of the leveraged leases being contested by the IRS, not just the single leveraged lease subject to the Court decision. Key’s second quarter results also reflect a $475 million charge to income taxes for the interest cost associated with the contested tax liabilities. These actions reduced Key’s taxable-equivalent net interest income and net interest margin for the second quarter of 2008 by $838 million and 376 basis points, respectively, and reduced Key’s earnings by $1.011 billion, or $2.43 per common share.

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During the first quarter of 2008, Key increased its tax reserves for certain LILO transactions, the deductions for which have been disallowed by the IRS. The change in the level of LILO reserves also necessitated a recalculation of lease income under FASB Staff Position No. 13-2. These actions reduced Key’s taxable-equivalent net interest income and net interest margin for the first quarter of 2008 by $34 million and 15 basis points, respectively, and reduced Key’s earnings by $38 million, or $.10 per diluted common share.
As previously reported, Service Contract Leases, LILO transactions and Qualified Technological Equipment Leases represent a portion of Key’s overall leveraged lease financing portfolio, and the tax deductions for some of these transactions are being challenged by the IRS. On August 6, 2008, the IRS announced a global initiative for the settlement of all transactions, including the contested leveraged leases entered into by Key, which the IRS has characterized as LILO/SILO transactions (the “LILO/SILO Settlement Initiative”). As preconditions to its participation, Key was required to provide written acceptance to the IRS of the terms of the LILO/SILO Settlement Initiative and to dismiss its appeal of the AWG Leasing Trust litigation. Key has complied with these preconditions and was accepted into the LILO/SILO Settlement Initiative by the IRS on October 6, 2008. However, Key’s acceptance into this initiative is not binding until a closing agreement is executed by both Key and the IRS. Management believes that, upon the execution of a closing agreement, Key should realize an after-tax recovery of between $75 million and $100 million for previously accrued interest on disputed tax balances. Additional information related to these lease financing transactions, and the related LILO/SILO Settlement Initiative is included in Note 12 (“Income Taxes”), which begins on page 27.
For the fourth quarter of 2008, management expects Key’s net interest margin to be in the range of 3.00% to 3.10%. Management believes the continuation of competitive pressure on deposit pricing and the effect of customer draws under existing lines of credit at relatively narrow spreads will offset the impact of more favorable spreads on new assets.
Since January 1, 2007, the growth and composition of Key’s earning assets have been affected by the following actions:
¨   During the first quarter of 2008, Key increased its loan portfolio (primarily commercial real estate and consumer loans) through the acquisition of U.S.B. Holding Co., Inc., the holding company for Union State Bank, a 31-branch state-chartered commercial bank headquartered in Orangeburg, New York.
 
¨   Key sold $1.7 billion of commercial real estate loans during the first nine months of 2008 and $3.8 billion ($238 million through a securitization) during all of 2007. 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 30. In June 2008, Key transferred $384 million of commercial real estate loans ($719 million, net of $335 million in net charge-offs) from the held-to-maturity loan portfolio to held-for-sale status as part of a process undertaken to aggressively reduce its exposure in the residential properties segment of its construction loan portfolio through the planned sale of certain loans. Additional information about the status of this process is included in the section entitled “Commercial real estate loans” on page 67.
 
¨   Key sold $120 million of education loans during the first nine months of 2008 and $247 million during all of 2007. In March 2008, Key transferred $3.3 billion of education loans from held-for-sale status to the held-to-maturity loan portfolio. The secondary markets for these loans have been adversely affected by market liquidity issues, prompting the company’s decision to move them to a held-to-maturity classification.
 
¨   Key sold $700 million of other loans (including $580 million of residential mortgage loans) during the first nine months of 2008 and $1.2 billion during all of 2007.

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Figure 9. Average Balance Sheets, Net Interest Income and Yields/Rates
From Continuing Operations
                                                 
    Third Quarter 2008     Second Quarter 2008  
    Average             Yield/     Average             Yield/  
dollars in millions   Balance     Interest     Rate     Balance     Interest     Rate  
 
ASSETS
                                               
Loans: a,b
                                               
Commercial, financial and agricultural
  $ 26,345     $ 356       5.38 %   $ 26,057     $ 352       5.42 %
Real estate — commercial mortgage
    10,718       158       5.87       10,593       156       5.91  
Real estate — construction
    7,806       109       5.53       8,484       118       5.61  
Commercial lease financing
    9,585       108       4.52     9,798       (709 )     (28.94 ) c
 
Total commercial loans
    54,454       731       5.35       54,932       (83 )     (.58 )
Real estate — residential
    1,899       28       6.04       1,918       30       6.12  
Home equity:
                                               
Community Banking
    9,887       141       5.64       9,765       140       5.78  
National Banking
    1,138       22       7.65       1,200       23       7.68  
 
Total home equity  loans
    11,025       163       5.85       10,965       163       5.99  
Consumer other — Community Banking
    1,264       33       10.37       1,271       33       10.34  
Consumer other — National Banking:
                                               
Marine
    3,586       57       6.33       3,646       56       6.26  
Education
    3,635       54       5.90       3,595       53       5.88  
Other
    308       6       8.22       325       7       8.21  
 
Total consumer other — National Banking
    7,529       117       6.20       7,566       116       6.16  
 
Total consumer loans
    21,717       341       6.25       21,720       342       6.32  
 
Total loans
    76,171       1,072       5.60       76,652       259       1.37  
Loans held for sale
    1,723       21       4.76       1,356       20       5.94  
Securities available for sale a,d
    8,266       110       5.38       8,315       111       5.40  
Held-to-maturity securities a
    27       1       13.81       25             11.47  
Trading account assets
    1,579       16       4.02       1,041       10       3.88  
Short-term investments
    794       6       3.44       773       8       3.83  
Other investments d
    1,563       12       2.87       1,580       14       3.09  
 
Total earning assets
    90,123       1,238       5.47       89,742       422       1.89  
Allowance for loan losses
    (1,498 )                     (1,338 )                
Accrued income and other assets
    14,531                       14,886                  
 
Total assets
  $ 103,156                     $ 103,290                  
 
                                           
 
                                               
LIABILITIES AND
SHAREHOLDERS’ EQUITY
                                               
NOW and money market deposit accounts
  $ 26,657       108       1.61     $ 27,158       102       1.51  
Savings deposits
    1,783       1       .21       1,815       1       .27  
Certificates of deposit ($100,000 or more)  e
    9,506       97       4.05       8,670       88       4.09  
Other time deposits
    13,118       129       3.92       12,751       135       4.27  
Deposits in foreign office
    2,762       12       1.77       4,121       21       1.95  
 
Total interest-bearing deposits
    53,826       347       2.57       54,515       347       2.56  
Federal funds purchased and securities sold under repurchase agreements 
    2,546       10       1.58       3,267       15       1.86  
Bank notes and other short-term borrowings 
    4,843       34       2.72       4,770       27       2.26  
Long-term debt e f
    15,123       142       3.91       14,620       133       3.87  
 
Total interest-bearing liabilities
    76,338       533       2.80       77,172       522       2.75  
Noninterest-bearing deposits
    10,756                       10,617                  
Accrued expense and other liabilities
    7,328                       6,884                  
 
Preferred stock
    657                       128                  
Common shareholders’ equity
    8,077                       8,489                  
 
Total shareholders’ equity
    8,734                       8,617                  
 
Total liabilities and shareholders’ equity
  $ 103,156                     $ 103,290                  
 
                                           
 
                                               
Interest rate spread (TE)
                    2.67 %                     (.86 )%
 
Net interest (loss) income (TE) and net interest margin (TE)
            705       3.13 %             (100 ) c     (.44 )% c
 
                                           
TE adjustment a
            6                       (458 )        
 
Net interest income, GAAP basis
          $ 699                     $ 358          
 
                                           
 
Average balances have not been restated to reflect Key’s January 1, 2008, adoption of FASB Interpretation No. 39, “Offsetting of Amounts Related to Certain Contracts,” and FASB Staff Position FIN 39-1, “Amendment of FASB Interpretation 39.” Key’s adoption of this accounting guidance is described in Note 1 (“Basis of Presentation”) under the heading “Accounting Pronouncements Adopted in 2008” on page 9.
(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)   During the second quarter of 2008, Key’s taxable-equivalent net interest income was reduced by $838 million as a result of an adverse federal court decision on Key’s tax treatment of a Service Contract Lease transaction. Excluding this reduction, the taxable-equivalent yield on Key’s commercial lease financing portfolio would have been 5.25% for the second quarter of 2008, and Key’s taxable-equivalent net interest margin would have been 3.32%. During the prior quarter, Key increased its tax reserves for certain LILO transactions and recalculated its lease income in accordance with prescribed accounting standards. These actions reduced Key’s first quarter 2008 taxable-equivalent net interest income by $34 million. Excluding this reduction, the taxable-equivalent yield on Key’s commercial lease financing portfolio would have been 5.27% for the first quarter of 2008, and Key’s taxable-equivalent net interest margin would have been 3.29%.

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Table of Contents

Figure 9. Average Balance Sheets, Net Interest Income and Yields/Rates
From Continuing Operations (Continued)
                                                                 
First Quarter 2008     Fourth Quarter 2007     Third Quarter 2007    
Average             Yield/     Average             Yield/     Average         Yield/    
Balance     Interest     Rate     Balance     Interest     Rate     Balance     Interest   Rate    
     
     
     
$ 25,411     $ 392       6.21 %   $ 23,825     $ 419       6.98 %   $ 22,393   $ 410   7.25 %
 
  10,283       175       6.84       9,351       175       7.42       8,855     172   7.69  
 
  8,468       134       6.36       8,192       153       7.42       8,285     167   8.01  
 
  10,004       98       3.91  c     10,252       171       6.65       10,172     147   5.80  
 
     
  54,166       799       5.93       51,620       918       7.06       49,705     896   7.16  
 
  1,916       30       6.29       1,596       27       6.72       1,586     26   6.68  
 
                                                                 
  9,693       154       6.38       9,658       168       6.92       9,690     175   7.14  
 
  1,260       24       7.74       1,259       24       7.77       1,193     24   7.85  
 
     
  10,953       178       6.54       10,917       192       7.02       10,883     199   7.22  
 
  1,305       34       10.59       1,308       35       10.73       1,342     36   10.66  
 
                                                                 
  3,646       58       6.31       3,608       58       6.34       3,506     55   6.32  
 
  363       7       8.04       329       8       9.47       332     8   9.65  
 
  339       7       8.32       339       7       8.66       326     7   8.92  
 
     
  4,348       72       6.61       4,276       73       6.76       4,164     70   6.79  
 
     
  18,522       314       6.81       18,097       327       7.20       17,975     331   7.33  
 
     
  72,688       1,113       6.15       69,717       1,245       7.10       67,680     1,227   7.20  
 
  4,984       87       7.01       4,748       89       7.53       4,731     91   7.59  
 
  8,419       110       5.28       7,858       115       5.89       7,825     106   5.45  
 
  29       1       11.02       30       1       6.24       36       6.43  
 
  1,075       13       4.84       1,042       12       4.40       1,055     11   4.39  
 
  1,165       9       3.18       1,226       13       3.94       633     5   3.32  
 
  1,552       12       3.05       1,589       12       3.02       1,563     12   2.99  
 
     
  89,912       1,345       6.01       86,210       1,487       6.86       83,523     1,452   6.92  
 
  (1,236 )                     (966 )                     (942 )  
 
       
  14,680                       13,547                       12,581    
 
       
     
$ 103,356                     $ 98,791                     $ 95,162    
 
       
                                                 
 
       
                                                               
 

 
                                                             
 
$ 26,996       139       2.07     $ 25,687       197       3.05     $ 24,190     209   3.41  
 
  1,865       3       .62       1,523       1       .19       1,581       .19  
 
  8,072       95       4.72       6,887       86       4.98       6,274     80   5.06  
 
  12,759       146       4.59       11,455       135       4.68       11,512     136   4.68  
 
  5,853       45       3.13       5,720       64       4.42       4,540     57   5.00  
 
     
  55,545       428       3.10       51,272       483       3.74       48,097     482   3.98  
 

 
3,863       28       2.91       4,194       45       4.23       4,470     55   4.85  
 
  4,934       39       3.22       4,233       45       4.15       2,539     30   4.70  
 
  13,238       146       4.71       11,851       164       5.72       11,801     173   5.89  
 
     
  77,580       641       3.36       71,550       737       4.11       66,907     740   4.40  
 
  10,741                       12,948                       14,424    
 
       
  6,590                       6,405                       6,106    
 
       
     
 
                                                 
 
       
  8,445                       7,888                       7,725    
 
       
     
  8,445                       7,888                       7,725    
 
       
     
$ 103,356                     $ 98,791                     $ 95,162    
 
       
                                                 
 
       
                                                               
 
                  2.65 %                     2.75 %               2.52 %
 
     

 
        704  c     3.14 % c             750       3.48 %           712   3.40 %
 
                                                         
 
          (9 )                     40                     18  
 
   
     
        $ 713                     $ 710                   $ 694