Edgar Filing: KEYCORP /NEW/

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington D.C. 20549

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2016

Commission File Number 001-11302

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 Number:


127 Public Square, Cleveland, Ohio		44114-1306
Address of principal executive offices:		Zip Code:

(216) 689-3000

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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

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		1,082,180,931 Shares
Title of class		Outstanding at August 1, 2016

KEYCORP

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION


		Page Number
Item 1.	Financial Statements		5

	Consolidated Balance Sheets — June 30, 2016 (Unaudited), December 31, 2015, and June 30, 2015 (Unaudited)		5

	Consolidated Statements of Income (Unaudited) — Three and six months ended June 30, 2016, and June 30, 2015		6

	Consolidated Statements of Comprehensive Income (Unaudited) — Three and six months ended June 30, 2016, and June 30, 2015		7

	Consolidated Statements of Changes in Equity (Unaudited) — Six months ended June 30, 2016, and June 30, 2015		8

	Consolidated Statements of Cash Flows (Unaudited) — Six months ended June 30, 2016, and June 30, 2015		9

	Notes to Consolidated Financial Statements (Unaudited)		10

	Note 1. Basis of Presentation and Accounting Policies		10
	Note 2. Earnings Per Common Share		15
	Note 3. Loans and Loans Held for Sale		16
	Note 4. Asset Quality		18
	Note 5. Fair Value Measurements		32
	Note 6. Securities		48
	Note 7. Derivatives and Hedging Activities		52
	Note 8. Mortgage Servicing Assets		60
	Note 9. Variable Interest Entities		62
	Note 10. Income Taxes		64
	Note 11. Acquisitions and Discontinued Operations		65
	Note 12. Securities Financing Activities		71
	Note 13. Employee Benefits		73
	Note 14. Trust Preferred Securities Issued by Unconsolidated Subsidiaries		74
	Note 15. Contingent Liabilities and Guarantees		75
	Note 16. Accumulated Other Comprehensive Income		77
	Note 17. Shareholders’ Equity		80
	Note 18. Line of Business Results		81

	Report of Ernst & Young LLP, Independent Registered Public Accounting Firm		85


Item 2.	Management’s Discussion & Analysis of Financial Condition & Results of Operations	86

	Introduction	86
	Terminology	86
	Selected financial data	87
	Forward-looking statements	88
	Economic overview	89
	Long-term financial goals	90
	Strategic developments	90
	Demographics	91
	Supervision and regulation	93

	Highlights of Our Performance	96
	Financial performance	96

	Results of Operations	101
	Net interest income	101
	Noninterest income	104
	Noninterest expense	107
	Income taxes	108

	Line of Business Results	109
	Key Community Bank summary of operations	109
	Key Corporate Bank summary of operations	110
	Other Segments	111

	Financial Condition	112
	Loans and loans held for sale	112
	Securities	119
	Other investments	122
	Deposits and other sources of funds	122
	Capital	123

	Risk Management	126
	Overview	126
	Market risk management	127
	Liquidity risk management	132
	Credit risk management	135
	Operational and compliance risk management	142

	Critical Accounting Policies and Estimates	143

	European Sovereign and Non-Sovereign Debt Exposures	144

Item 3.	Quantitative and Qualitative Disclosure about Market Risk	145

Item 4.	Controls and Procedures	145


	PART II. OTHER INFORMATION

Item 1.	Legal Proceedings	145
Item 1A.	Risk Factors	145
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	146
Item 6.	Exhibits	146
	Signature	147

Throughout the Notes to Consolidated Financial Statements (Unaudited) and Management’s Discussion & Analysis of Financial Condition & Results of Operations, we use certain acronyms and abbreviations as defined in Note 1 (“Basis of Presentation and Accounting Policies”) that begins on page 10.

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

Consolidated Balance Sheets


in millions, except per share data	June 30, 2016			December 31, 2015			June 30, 2015
	(Unaudited)						(Unaudited)
ASSETS
Cash and due from banks	$	496		$	607		$	693
Short-term investments		6,599			2,707			3,222
Trading account assets		965			788			674
Securities available for sale		14,552			14,218			14,244
Held-to-maturity securities (fair value: $4,889, $4,848, and $4,992)		4,832			4,897			5,022
Other investments		577			655			703
Loans, net of unearned income of $615, $646, and $657		62,098			59,876			58,264
Less: Allowance for loan and lease losses		854			796			796

Net loans		61,244			59,080			57,468
Loans held for sale		442			639			835
Premises and equipment		742			779			788
Operating lease assets		399			340			296
Goodwill		1,060			1,060			1,057
Other intangible assets		50			65			83
Corporate-owned life insurance		3,568			3,541			3,502
Derivative assets		1,234			619			536
Accrued income and other assets		2,673			3,290			3,312
Discontinued assets (including $3 and $4 million of portfolio loans at fair value and $179 million of portfolio loans held for sale at fair value, see Note 11)		1,717			1,846			2,169

Total assets	$	101,150		$	95,131		$	94,604

LIABILITIES
Deposits in domestic offices:
NOW and money market deposit accounts	$	40,195		$	37,089		$	36,024
Savings deposits		2,355			2,341			2,370
Certificates of deposit ($100,000 or more)		3,381			2,392			2,032
Other time deposits		3,267			3,127			3,105

Total interest-bearing deposits		49,198			44,949			43,531
Noninterest-bearing deposits		26,127			26,097			26,640
Deposits in foreign office — interest-bearing		—			—			498

Total deposits		75,325			71,046			70,669
Federal funds purchased and securities sold under repurchase agreements		360			372			444
Bank notes and other short-term borrowings		687			533			528
Derivative liabilities		746			632			560
Accrued expense and other liabilities		1,326			1,605			1,537
Long-term debt		11,388			10,184			10,265

Total liabilities		89,832			84,372			84,003

EQUITY
Preferred stock, $1 par value, authorized 25,000,000 shares:
7.75% Noncumulative Perpetual Convertible Preferred Stock, Series A, $100 liquidation preference; authorized 2,900,234 shares; issued 2,900,234, 2,900,234, and 2,900,234 shares		290			290			290
Common shares, $1 par value; authorized 1,400,000,000 shares; issued 1,016,969,905, 1,016,969,905, and 1,016,969,905 shares		1,017			1,017			1,017
Capital surplus		3,835			3,922			3,898
Retained earnings		9,166			8,922			8,614
Treasury stock, at cost (174,267,011, 181,218,648, and 173,362,345 shares)		(2,881	)		(3,000	)		(2,884	)
Accumulated other comprehensive income (loss)		(114	)		(405	)		(345	)

Key shareholders’ equity		11,313			10,746			10,590
Noncontrolling interests		5			13			11

Total equity		11,318			10,759			10,601

Total liabilities and equity	$	101,150		$	95,131		$	94,604

See Notes to Consolidated Financial Statements (Unaudited).

Consolidated Statements of Income (Unaudited)


	Three months ended June 30,					Six months ended June 30,
dollars in millions, except per share amounts	2016			2015		2016			2015
INTEREST INCOME
Loans	$	567		$	532	$	1,129		$	1,055
Loans held for sale		5			12		13			19
Securities available for sale		74			72		149			142
Held-to-maturity securities		24			24		48			48
Trading account assets		6			5		13			10
Short-term investments		6			2		10			4
Other investments		2			5		5			10

Total interest income		684			652		1,367			1,288

INTEREST EXPENSE
Deposits		34			26		65			52
Bank notes and other short-term borrowings		3			2		5			4
Long-term debt		50			40		96			77

Total interest expense		87			68		166			133

NET INTEREST INCOME		597			584		1,201			1,155
Provision for credit losses		52			41		141			76

Net interest income after provision for credit losses		545			543		1,060			1,079

NONINTEREST INCOME
Trust and investment services income		110			111		219			220
Investment banking and debt placement fees		98			141		169			209
Service charges on deposit accounts		68			63		133			124
Operating lease income and other leasing gains		18			24		35			43
Corporate services income		53			43		103			86
Cards and payments income		52			47		98			89
Corporate-owned life insurance income		28			30		56			61
Consumer mortgage income		3			4		5			7
Mortgage servicing fees		10			9		22			22
Net gains (losses) from principal investing		11			11		11			40
Other income^(a)		22			5		53			24

Total noninterest income		473			488		904			925

NONINTEREST EXPENSE
Personnel		427			408		831			797
Net occupancy		59			66		120			131
Computer processing		45			42		88			80
Business services and professional fees		40			42		81			75
Equipment		21			22		42			44
Operating lease expense		14			12		27			23
Marketing		22			15		34			23
FDIC assessment		8			8		17			16
Intangible asset amortization		7			9		15			18
OREO expense, net		2			1		3			3
Other expense		106			86		196			170

Total noninterest expense		751			711		1,454			1,380

INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES		267			320		510			624
Income taxes		69			84		125			158

INCOME (LOSS) FROM CONTINUING OPERATIONS		198			236		385			466
Income (loss) from discontinued operations, net of taxes of $2, $2, $2, and $5 (see Note 11)		3			3		4			8

NET INCOME (LOSS)		201			239		389			474
Less: Net income (loss) attributable to noncontrolling interests		(1	)		1		(1	)		3

NET INCOME (LOSS) ATTRIBUTABLE TO KEY	$	202		$	238	$	390		$	471

Income (loss) from continuing operations attributable to Key common shareholders	$	193		$	230	$	375		$	452
Net income (loss) attributable to Key common shareholders		196			233		379			460
Per common share:
Income (loss) from continuing operations attributable to Key common shareholders	$	.23		$	.27	$	.45		$	.53
Income (loss) from discontinued operations, net of taxes		—			—		—			.01
Net income (loss) attributable to Key common shareholders ^(b)		.23			.28		.45			.54
Per common share — assuming dilution:
Income (loss) from continuing operations attributable to Key common shareholders	$	.23		$	.27	$	.44		$	.52
Income (loss) from discontinued operations, net of taxes		—			—		—			.01
Net income (loss) attributable to Key common shareholders ^(b)		.23			.27		.45			.53
Cash dividends declared per common share	$	.085		$	.075	$	.16		$	.14
Weighted-average common shares outstanding (000)		831,899			839,454		829,640			843,992
Effect of convertible preferred stock		—			—		—			—
Effect of common share options and other stock awards		6,597			6,858		7,138			7,695

Weighted-average common shares and potential common shares outstanding (000)^(c)		838,496			846,312		836,778			851,687

(a)	For the three months ended June 30, 2016, and June 30, 2015, net securities gains (losses) totaled less than $1 million. For the three months ended June 30, 2016, and June 30, 2015, we did not have any impairment losses related to securities.

(b)	EPS may not foot due to rounding.

(c)	Assumes conversion of common share options and other stock awards and/or convertible preferred stock, as applicable.

See Notes to Consolidated Financial Statements (Unaudited).

Consolidated Statements of Comprehensive Income (Unaudited)


	Three months ended June 30,						Six months ended June 30,
in millions	2016			2015			2016			2015
Net income (loss)	$	201		$	239		$	389		$	474
Other comprehensive income (loss), net of tax:
Net unrealized gains (losses) on securities available for sale, net of income taxes of $35, ($31), $111 and $2		59			(51	)		187			4
Net unrealized gains (losses) on derivative financial instruments, net of income taxes of $22, ($10), $56, and $9		36			(17	)		94			15
Foreign currency translation adjustments, net of income taxes of $1, $0, $4, and ($8)		2			—			7			(13	)
Net pension and postretirement benefit costs, net of income taxes of $1, $2, $5, and $3		2			2			3			5

Total other comprehensive income (loss), net of tax		99			(66	)		291			11

Comprehensive income (loss)		300			173			680			485
Less: Comprehensive income attributable to noncontrolling interests		(1	)		1			(1	)		3

Comprehensive income (loss) attributable to Key	$	301		$	172		$	681		$	482

See Notes to Consolidated Financial Statements (Unaudited).

Consolidated Statements of Changes in Equity (Unaudited)


	Key Shareholders’ Equity
dollars in millions, except per share amounts	Preferred Shares Outstanding (000)			Common Shares Outstanding (000)			Preferred Stock			Common Shares		Capital Surplus			Retained Earnings			Treasury Stock, at Cost			Accumulated Other Comprehensive Income (Loss)			Noncontrolling Interests
BALANCE AT DECEMBER 31, 2014		2,905			859,403		$	291		$	1,017	$	3,986		$	8,273		$	(2,681	)	$	(356	)	$	12
Net income (loss)																471									3
Other comprehensive income (loss):
Net unrealized gains (losses) on securities available for sale, net of income taxes of $2																						4
Net unrealized gains (losses) on derivative financial instruments, net of income taxes of $9																						15
Foreign currency translation adjustments, net of income taxes of ($8)																						(13	)
Net pension and postretirement benefit costs, net of income taxes of $3																						5
Deferred compensation													12
Cash dividends declared on common shares ($.14 per share)																(119	)
Cash dividends declared on Noncumulative Series A Preferred Stock ($3.875 per share)																(11	)
Common shares repurchased					(22,881	)													(325	)
Series A Preferred Stock exchanged for common shares		(5	)		33			(1	)										1
Common shares reissued (returned) for stock options and other employee benefit plans					7,053								(100	)					121
Net contribution from (distribution to) noncontrolling interests																									(4	)

BALANCE AT JUNE 30, 2015		2,900			843,608		$	290		$	1,017	$	3,898		$	8,614		$	(2,884	)	$	(345	)	$	11

BALANCE AT DECEMBER 31, 2015		2,900			835,751		$	290		$	1,017	$	3,922		$	8,922		$	(3,000	)	$	(405	)	$	13
Net income (loss)																390									(1	)
Other comprehensive income (loss):
Net unrealized gains (losses) on securities available for sale, net of income taxes of $111																						187
Net unrealized gains (losses) on derivative financial instruments, net of income taxes of $56																						94
Foreign currency translation adjustments, net of income taxes of $4																						7
Net pension and postretirement benefit costs, net of income taxes of $5																						3
Deferred compensation													(4	)
Cash dividends declared on common shares ($.16 per share)																(135	)
Cash dividends declared on Noncumulative Series A Preferred Stock ($3.875 per share)																(11	)
Common shares reissued (returned) for stock options and other employee benefit plans					6,952								(83	)					119
Net contribution from (distribution to) noncontrolling interests																									(7	)

BALANCE AT JUNE 30, 2016		2,900			842,703		$	290		$	1,017	$	3,835		$	9,166		$	(2,881	)	$	(114	)	$	5

See Notes to Consolidated Financial Statements (Unaudited).

Consolidated Statements of Cash Flows (Unaudited)


	Six months ended June 30,
in millions	2016			2015
OPERATING ACTIVITIES
Net income (loss)	$	389		$	474
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Provision for credit losses		141			76
Depreciation, amortization and accretion expense, net		124			116
Increase in cash surrender value of corporate-owned life insurance		(49	)		(50	)
Stock-based compensation expense		36			33
FDIC reimbursement (payments), net of FDIC expense		—			(1	)
Deferred income taxes (benefit)		27			(27	)
Proceeds from sales of loans held for sale		2,940			3,726
Originations of loans held for sale, net of repayments		(2,691	)		(3,756	)
Net losses (gains) on sales of loans held for sale		(31	)		(55	)
Net losses (gains) from principal investing		(11	)		(40	)
Net losses (gains) and writedown on OREO		2			2
Net losses (gains) on leased equipment		1			(9	)
Net securities losses (gains)		—			1
Net losses (gains) on sales of fixed assets		3			2
Net decrease (increase) in trading account assets		(177	)		76
Other operating activities, net		20			(509	)

NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES		724			59
INVESTING ACTIVITIES
Net decrease (increase) in short-term investments, excluding acquisitions		(3,892	)		1,047
Purchases of securities available for sale		(1,614	)		(2,451	)
Proceeds from sales of securities available for sale		—			11
Proceeds from prepayments and maturities of securities available for sale		1,565			1,547
Proceeds from prepayments and maturities of held-to-maturity securities		586			566
Purchases of held-to-maturity securities		(523	)		(575	)
Purchases of other investments		(24	)		(20	)
Proceeds from sales of other investments		77			77
Proceeds from prepayments and maturities of other investments		1			5
Net decrease (increase) in loans, excluding acquisitions, sales and transfers		(2,429	)		(1,128	)
Proceeds from sales of portfolio loans		72			67
Proceeds from corporate-owned life insurance		22			26
Purchases of premises, equipment, and software		(30	)		(17	)
Proceeds from sales of OREO		7			10

NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES		(6,182	)		(835	)
FINANCING ACTIVITIES
Net increase (decrease) in deposits, excluding acquisitions		4,279			(1,329	)
Net increase (decrease) in short-term borrowings		142			(26	)
Net proceeds from issuance of long-term debt		1,578			2,750
Payments on long-term debt		(509	)		(141	)
Repurchase of common shares		—			(325	)
Net proceeds from reissuance of common shares		3			17
Cash dividends paid		(146	)		(130	)

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		5,347			816

NET INCREASE (DECREASE) IN CASH AND DUE FROM BANKS		(111	)		40
CASH AND DUE FROM BANKS AT BEGINNING OF PERIOD		607			653

CASH AND DUE FROM BANKS AT END OF PERIOD	$	496		$	693

Additional disclosures relative to cash flows:
Interest paid	$	190		$	149
Income taxes paid (refunded)		59			90
Noncash items:
Reduction of secured borrowing and related collateral	$	33		$	103
Loans transferred to portfolio from held for sale		6			—
Loans transferred to held for sale from portfolio		28			16
Loans transferred to OREO		10			12

See Notes to Consolidated Financial Statements (Unaudited).

Notes to Consolidated Financial Statements (Unaudited)

1. Basis of Presentation and Accounting Policies

As used in these Notes, references to “Key,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of KeyCorp and its subsidiaries. KeyCorp refers solely to the parent holding company, and KeyBank refers to KeyCorp’s subsidiary, KeyBank National Association.

The acronyms and abbreviations identified below are used in the Notes to Consolidated Financial Statements (Unaudited) as well as in the Management’s Discussion & Analysis of Financial Condition & Results of Operations. You may find it helpful to refer back to this page as you read this report.

References to our “2015 Form 10-K” refer to our Form 10-K for the year ended December 31, 2015, which was filed with the U.S. Securities and Exchange Commission and is available on its website (www.sec.gov) and on our website (www.key.com/ir).


AICPA: American Institute of Certified Public Accountants.		KCDC: Key Community Development Corporation.
ALCO: Asset/Liability Management Committee.		KEF: Key Equipment Finance.
ALLL: Allowance for loan and lease losses.		KPP: Key Principal Partners.
A/LM: Asset/liability management.		KREEC: Key Real Estate Equity Capital, Inc.
AOCI: Accumulated other comprehensive income (loss).		LCR: Liquidity coverage ratio.
APBO: Accumulated postretirement benefit obligation.		LIBOR: London Interbank Offered Rate.
Austin: Austin Capital Management, Ltd.		LIHTC: Low-income housing tax credit.
BHCs: Bank holding companies.		Moody’s: Moody’s Investor Services, Inc.
Board: KeyCorp Board of Directors.		MRM: Market Risk Management group.
CCAR: Comprehensive Capital Analysis and Review.		N/A: Not applicable.
CMBS: Commercial mortgage-backed securities.		NASDAQ: The NASDAQ Stock Market LLC.
CMO: Collateralized mortgage obligation.		NAV: Net asset value.
Common shares: KeyCorp common shares, $1 par value.		N/M: Not meaningful.
DIF: Deposit Insurance Fund of the FDIC.		NOW: Negotiable Order of Withdrawal.
Dodd-Frank Act: Dodd-Frank Wall Street Reform and		NPR: Notice of proposed rulemaking.
Consumer Protection Act of 2010.		NYSE: New York Stock Exchange.
EBITDA: Earnings before interest, taxes, depreciation, and		OCC: Office of the Comptroller of the Currency.
amortization.		OCI: Other comprehensive income (loss).
EPS: Earnings per share.		OREO: Other real estate owned.
ERISA: Employee Retirement Income Security Act of 1974.		OTTI: Other-than-temporary impairment.
ERM: Enterprise risk management.		PBO: Projected benefit obligation.
EVE: Economic value of equity.		PCI: Purchased credit impaired.
FASB: Financial Accounting Standards Board.		S&P: Standard and Poor’s Ratings Services, a Division of The
FDIC: Federal Deposit Insurance Corporation.		McGraw-Hill Companies, Inc.
Federal Reserve: Board of Governors of the Federal Reserve		SEC: U.S. Securities and Exchange Commission.
System.		Series A Preferred Stock: KeyCorp’s 7.750% Noncumulative
FHLB: Federal Home Loan Bank of Cincinnati.		Perpetual Convertible Preferred Stock, Series A.
FHLMC: Federal Home Loan Mortgage Corporation.		SIFIs: Systemically important financial institutions, including
First Niagara: First Niagara Financial Group, Inc.		BHCs with total consolidated assets of at least $50 billion
(NASDAQ: FNFG).		and nonbank financial companies designated by FSOC for
FNMA: Federal National Mortgage Association, or Fannie Mae.		supervision by the Federal Reserve.
FSOC: Financial Stability Oversight Council.		TDR: Troubled debt restructuring.
GAAP: U.S. generally accepted accounting principles.		TE: Taxable-equivalent.
GNMA: Government National Mortgage Association.		U.S. Treasury: United States Department of the Treasury.
ISDA: International Swaps and Derivatives Association.		VaR: Value at risk.
KAHC: Key Affordable Housing Corporation.		VEBA: Voluntary Employee Beneficiary Association.
KCC: Key Capital Corporation.		VIE: Variable interest entity.

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

The consolidated financial statements include any voting rights entities in which we have a controlling financial interest. In accordance with the applicable accounting guidance for consolidations, we consolidate a VIE if we have: (i) a variable interest in the entity; (ii) the power to direct activities of the VIE that most significantly impact the entity’s economic performance; and (iii) the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE (i.e., we are considered to be the primary beneficiary). Variable interests can include equity interests, subordinated debt, derivative contracts, leases, service agreements, guarantees, standby letters of credit, loan commitments, and other contracts, agreements, and financial instruments. See Note 9 (“Variable Interest Entities”) for information on our involvement with VIEs.

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

We believe that the unaudited consolidated interim financial statements reflect all adjustments of a normal recurring nature and disclosures that are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim period are not necessarily indicative of the results of operations to be expected for the full year. The interim financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our 2015 Form 10-K.

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

Offsetting Derivative Positions

In accordance with the applicable accounting guidance, we take into account the impact of bilateral collateral and master netting agreements that allow us 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 when recognizing derivative assets and liabilities. Additional information regarding derivative offsetting is provided in Note 7 (“Derivatives and Hedging Activities”).

Accounting Guidance Adopted in 2016

Business combinations. In September 2015, the FASB issued new accounting guidance that obligates an acquirer in a business combination to recognize adjustments to provisional amounts in the reporting period that the amounts were determined, eliminating the requirement for retrospective adjustments. The acquirer should record in the current period any income effects that resulted from the change in provisional amounts, calculated as if the accounting were completed at the acquisition date. This accounting guidance was effective prospectively for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us). Early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Fair value measurement. In May 2015, the FASB issued new disclosure guidance that eliminates the requirement to categorize investments measured using the net asset value practical expedient in the fair value hierarchy table. Entities are required to disclose the fair value of investments measured using the net asset value practical expedient so that financial statement users can reconcile amounts reported in the fair value hierarchy table to amounts reported on the balance sheet. This disclosure guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (March 31, 2016, for us) on a retrospective basis. Early adoption was permitted. The adoption of this disclosure guidance did not affect our financial condition or results of operations. We provide the disclosure related to this new guidance in Note 5 (“Fair Value Measurements”).

Cloud computing fees. In April 2015, the FASB issued new accounting guidance that clarifies a customer’s accounting for fees paid in a cloud computing arrangement. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a

service contract. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using either a prospective method or a retrospective method. Early adoption was permitted. We elected to implement this new accounting guidance using a prospective approach. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Imputation of interest. In April 2015, the FASB issued new accounting guidance that requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This accounting guidance was effective retrospectively for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us). Early adoption was permitted. The adoption of this accounting guidance did not have a material effect on our financial condition or results of operations.

Consolidation. In February 2015, the FASB issued new accounting guidance that changes the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The new guidance amends the current accounting guidance to address limited partnerships and similar legal entities, certain investment funds, fees paid to a decision maker or service provider, and the impact of fee arrangements and related parties on the primary beneficiary determination. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and was implemented using a modified retrospective basis. Retrospective application to all relevant prior periods and early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations. Our Principal Investing unit and the Real Estate Capital line of business have equity and mezzanine investments, which were subjected to the new guidance. We determined these investments are VIEs. We provide disclosures related to our variable interest entities as required by the new guidance in Note 9 (“Variable Interest Entities”).

Derivatives and hedging. In November 2014, the FASB issued new accounting guidance that clarifies how current guidance should be interpreted when evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. An entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, when evaluating the nature of a host contract. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using a modified retrospective basis. Retrospective application to all relevant prior periods and early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Consolidation. In August 2014, the FASB issued new accounting guidance that clarifies how to measure the financial assets and the financial liabilities of a consolidated collateralized financing entity. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using either a retrospective method or a cumulative-effect approach. Early adoption was permitted. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Stock-based compensation. In June 2014, the FASB issued new accounting guidance that clarifies how to account for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2015 (effective January 1, 2016, for us) and could be implemented using either a retrospective method or a prospective method. Early adoption was permitted. We elected to implement this new accounting guidance using a prospective approach. The adoption of this accounting guidance did not affect our financial condition or results of operations.

Accounting Guidance Pending Adoption at June 30, 2016

Financial instruments. In June 2016, the FASB issued new accounting guidance that changes the methodology for recognizing credit losses related to financial instruments. Under current GAAP, a credit loss is not recognized until it is probable the loss has been incurred. The new accounting guidance eliminates that threshold and expands the information required for an entity to consider when developing an estimate of expected credit losses, including the use of forecasted information. Entities will be required to present financial assets measured on an amortized cost basis at the net amount that is expected to be collected. This new guidance will impact the accounting for our loans, debt securities available for sale, and liability for credit losses on unfunded lending-related commitments as well as purchased financial assets with a more than insignificant amount of credit deterioration since origination. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2019 (effective January 1, 2020, for us). Early adoption is permitted but only for interim and annual reporting periods beginning after December 15, 2018. This guidance must be implemented using a modified retrospective basis except a prospective approach must be used for debt securities for which an other-than-

temporary impairment had been recognized before the effective date. A prospective transition approach also should be used for purchased financial assets with credit deterioration. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Stock-based compensation. In March 2016, the FASB issued new accounting guidance that simplifies accounting for several aspects of share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and presentation on the statement of cash flows. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us). The method of transition is dependent on the particular amendment within the new guidance. Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Equity method investments. In March 2016, the FASB issued new accounting guidance that simplifies the transition to equity method accounting by eliminating the requirement for an investor to make retroactive adjustments to the investment, results of operations, and retained earnings on a step-by-step basis when an investment becomes qualified for equity method accounting. Instead, when an investment qualifies for the equity method due to an increase in ownership or degree of influence, an equity method investor is required to add the cost of acquiring the additional interest to the current basis of the previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for the equity method. This accounting guidance will be effective prospectively for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us). Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Derivatives and hedging. In March 2016, the FASB issued new accounting guidance that requires an entity to use a four-step decision model when assessing contingent call (put) options that can accelerate the payment of principal on debt instruments to determine whether they are clearly and closely related to their debt hosts. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us) and must be implemented using a modified retrospective basis. Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Derivatives and hedging. In March 2016, the FASB issued new accounting guidance that clarifies that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument does not, by itself, require dedesignation, but all other hedge accounting criteria must be met. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us) and can be implemented using either a prospective method or a modified retrospective method. Early adoption is permitted. We have elected to implement this new accounting guidance using a prospective method. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Extinguishment of liabilities. In March 2016, the FASB issued new accounting guidance that clarifies that liabilities related to the sale of prepaid stored-value products are financial liabilities, and breakage should be accounted for under the breakage guidance in the new revenue recognition accounting guidance. It also provides clarity on how prepaid product liabilities should be derecognized. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us) and can be implemented using either a modified retrospective approach or retrospective approach. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Leases. In February 2016, the FASB issued new accounting guidance that requires a lessee to recognize a liability to make lease payments and a right of use asset representing its right to use an underlying asset during the lease term for both finance and operating leases. The definition of a lease was modified to exemplify the concept of control over an asset identified in the lease. Lease classification criteria remains substantially similar to criteria in current lease guidance. The guidance defines which payments can be used in determining lease classification. For short-term leases with a term of 12 months or less, lessees can make a policy election not to recognize lease assets and lease liabilities. Lessor accounting is largely unchanged. Leveraged leases that commenced before the effective date of the new guidance are grandfathered. New disclosures are required, and certain practical expedients are allowed upon adoption. This accounting and disclosure guidance will be effective for interim and annual reporting periods beginning after December 15, 2018 (effective January 1, 2019, for us) and should be implemented using the modified retrospective approach. Early adoption is permitted. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Financial instruments. In January 2016, the FASB issued new accounting guidance that requires equity investments, except those accounted for under the equity method of accounting or consolidated, to be measured at fair value with changes recognized in net income. If there is no readily determinable fair value, the guidance allows entities the ability to measure investments at cost less impairment, whereby impairment is based on a qualitative assessment. The guidance eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments measured at amortized cost and changes the presentation of financial assets and financial liabilities on the balance sheet or in the footnotes. If an entity has elected the fair value option to measure liabilities, the new accounting guidance requires the portion of the change in the fair value of a liability resulting from credit risk to be presented in OCI. We have not elected to measure any of our liabilities at fair value, and therefore, this aspect of the guidance is not applicable to us. This accounting and disclosure guidance will be effective for interim and annual reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us). For the guidance applicable to us, the accounting will be implemented on a prospective basis, whereby early adoption is not permitted. We are currently evaluating the impact that this accounting guidance may have on our financial condition or results of operations.

Going concern. In August 2014, the FASB issued new accounting guidance that requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. Disclosure is required when conditions or events raise substantial doubt about an entity’s ability to continue as a going concern. This accounting guidance will be effective for interim and annual reporting periods beginning after December 15, 2016 (effective January 1, 2017, for us). Early adoption is permitted. The adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations.

Revenue recognition. In May 2014, the FASB issued new accounting guidance that revises the criteria for determining when to recognize revenue from contracts with customers and expands disclosure requirements. This accounting guidance can be implemented using either a retrospective method or a cumulative-effect approach. In August 2015, the FASB issued an update that defers the effective date of the revenue recognition guidance by one year. This new guidance will be effective for interim and annual reporting periods beginning after December 15, 2017 (effective January 1, 2018, for us). Early adoption is permitted but only for interim and annual reporting periods beginning after December 15, 2016. We have elected to implement this new accounting guidance using a cumulative-effect approach. Our preliminary analysis suggests that the adoption of this accounting guidance is not expected to have a material effect on our financial condition or results of operations. There are many aspects of this new accounting guidance that are still being interpreted, and the FASB has recently issued updates to certain aspects of the guidance to address implementation issues. For example, the FASB issued accounting guidance in March 2016 to clarify principal versus agent considerations and additional guidance in April 2016 to clarify the identification of performance obligations and the licensing implementation guidance. In May 2016, the FASB issued narrow-scope improvements related to collectability, sales tax and noncash consideration, and practical expedients for contract modifications and completed contracts. The results of our materiality analysis may change based on the conclusions reached as to the application of the new guidance.

2. Earnings Per Common Share

Basic earnings per share is the amount of earnings (adjusted for dividends declared on our preferred stock) available to each common share outstanding during the reporting periods. Diluted earnings per share is the amount of earnings available to each common share outstanding during the reporting periods adjusted to include the effects of potentially dilutive common shares. Potentially dilutive common shares include incremental shares issued for the conversion of our convertible Series A Preferred Stock, stock options, and other stock-based awards. Potentially dilutive common shares are excluded from the computation of diluted earnings per share in the periods where the effect would be antidilutive. For diluted earnings per share, net income available to common shareholders can be affected by the conversion of our convertible Series A Preferred Stock. Where the effect of this conversion would be dilutive, net income available to common shareholders is adjusted by the amount of preferred dividends associated with our Series A Preferred Stock.

Our basic and diluted earnings per common share are calculated as follows:


	Three months ended June 30,					Six months ended June 30,
dollars in millions, except per share amounts	2016			2015		2016			2015
EARNINGS
Income (loss) from continuing operations	$	198		$	236	$	385		$	466
Less: Net income (loss) attributable to noncontrolling interests		(1	)		1		(1	)		3

Income (loss) from continuing operations attributable to Key		199			235		386			463
Less: Dividends on Series A Preferred Stock		6			5		11			11

Income (loss) from continuing operations attributable to Key common shareholders		193			230		375			452
Income (loss) from discontinued operations, net of taxes^(a)		3			3		4			8

Net income (loss) attributable to Key common shareholders	$	196		$	233	$	379		$	460

WEIGHTED-AVERAGE COMMON SHARES
Weighted-average common shares outstanding (000)		831,899			839,454		829,640			843,992
Effect of convertible preferred stock		—			—		—			—
Effect of common share options and other stock awards		6,597			6,858		7,138			7,695

Weighted-average common shares and potential common shares outstanding (000)^(b)		838,496			846,312		836,778			851,687

EARNINGS PER COMMON SHARE

Income (loss) from continuing operations attributable to Key common shareholders	$	.23		$	.27	$	.45		$	.53
Income (loss) from discontinued operations, net of taxes^(a)		—			—		—			.01
Net income (loss) attributable to Key common shareholders^(c)		.23			.28		.45			.54

Income (loss) from continuing operations attributable to Key common shareholders — assuming dilution	$	.23		$	.27	$	.44		$	.52
Income (loss) from discontinued operations, net of taxes^(a)		—			—		—			.01
Net income (loss) attributable to Key common shareholders — assuming dilution^(c)		.23			.27		.45			.53

(a)

In September 2009, we decided to discontinue the education lending business conducted through Key Education Resources, the education payment and financing unit of KeyBank. As a result of this decision, we have accounted for this business as a discontinued operation. For further discussion regarding the income (loss) from discontinued operations, see Note 11 (“Acquisitions and Discontinued Operations”).

(b)	Assumes conversion of common share options and other stock awards and/or convertible preferred stock, as applicable.

(c)	EPS may not foot due to rounding.

3. Loans and Loans Held for Sale

Our loans by category are summarized as follows:


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Commercial, financial and agricultural^(a)	$	33,376	$	31,240	$	29,285
Commercial real estate:
Commercial mortgage		8,582		7,959		7,874
Construction		881		1,053		1,254

Total commercial real estate loans		9,463		9,012		9,128
Commercial lease financing^(b)		3,988		4,020		4,010

Total commercial loans		46,827		44,272		42,423
Residential — prime loans:
Real estate — residential mortgage		2,285		2,242		2,252
Home equity loans		10,062		10,335		10,532

Total residential — prime loans		12,347		12,577		12,784
Consumer direct loans		1,584		1,600		1,595
Credit cards		813		806		753
Consumer indirect loans		527		621		709

Total consumer loans		15,271		15,604		15,841

Total loans^{(c) (d)}	$	62,098	$	59,876	$	58,264

(a)	Loan balances include $88 million, $85 million, and $89 million of commercial credit card balances at June 30, 2016, December 31, 2015, and June 30, 2015, respectively.

(b)

Commercial lease financing includes receivables held as collateral for a secured borrowing of $102 million, $134 million, and $191 million at June 30, 2016, December 31, 2015, and June 30, 2015, respectively. Principal reductions are based on the cash payments received from these related receivables. Additional information pertaining to this secured borrowing is included in Note 18 (“Long-Term Debt”) beginning on page 208 of our 2015 Form 10-K.

(c)

At June 30, 2016, total loans include purchased loans of $104 million, of which $11 million were PCI loans. At December 31, 2015, total loans include purchased loans of $114 million, of which $11 million were PCI loans. At June 30, 2015, total loans include purchased loans of $125 million, of which $12 million were PCI loans.

(d)

Total loans exclude loans of $1.7 billion at June 30, 2016, $1.8 billion at December 31, 2015, and $2 billion at June 30, 2015, related to the discontinued operations of the education lending business. Additional information pertaining to these loans is provided in Note 11 (“Acquisitions and Discontinued Operations”).

Our loans held for sale are summarized as follows:


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Commercial, financial and agricultural	$	150	$	76	$	217
Real estate — commercial mortgage		270		532		576
Commercial lease financing		3		14		7
Real estate — residential mortgage		19		17		35

Total loans held for sale	$	442	$	639	$	835

Our quarterly summary of changes in loans held for sale follows:


in millions	June 30, 2016			December 31, 2015			June 30, 2015
Balance at beginning of the period	$	684		$	916		$	1,649
New originations		1,539			1,655			1,650
Transfers from (to) held to maturity, net		22			22			6
Loan sales		(1,802	)		(1,943	)		(2,466	)
Loan draws (payments), net		(1	)		(11	)		(4	)

Balance at end of period	$	442		$	639		$	835

4. Asset Quality

We assess the credit quality of the loan portfolio by monitoring net credit losses, levels of nonperforming assets and delinquencies, and credit quality ratings as defined by management.

Nonperforming loans are loans for which we do not accrue interest income, and include commercial and consumer loans and leases, as well as current year TDRs and nonaccruing TDR loans from prior years. Nonperforming loans do not include loans held for sale or PCI loans. Nonperforming assets include nonperforming loans, nonperforming loans held for sale, OREO, and other nonperforming assets.

Our nonperforming assets and past due loans were as follows:


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Total nonperforming loans^{(a), (b)}	$	619	$	387	$	419
OREO^(c)		15		14		20
Other nonperforming assets		3		2		1

Total nonperforming assets^(a)	$	637	$	403	$	440

Nonperforming assets from discontinued operations—education lending^(d)	$	5	$	7	$	6

Restructured loans included in nonperforming loans^(a)	$	133	$	159	$	170
Restructured loans with an allocated specific allowance^(e)		54		69		79
Specifically allocated allowance for restructured loans^(f)		34		30		36

Accruing loans past due 90 days or more	$	70	$	72	$	66
Accruing loans past due 30 through 89 days		203		208		181

(a)	Nonperforming loan balances exclude $11 million, $11 million, and $12 million of PCI loans at June 30, 2016, December 31, 2015, and June 30, 2015, respectively.

(b)	Includes carrying value of consumer residential mortgage loans in the process of foreclosure of approximately $111 million, $114 million, and $116 million at June 30, 2016, December 31, 2015, and June 30, 2015, respectively.

(c)	Includes carrying value of foreclosed residential real estate of approximately $12 million, $11 million, and $15 million at June 30, 2016, December 31, 2015, and June 30, 2015, respectively.

(d)	Restructured loans of approximately $22 million, $21 million, and $19 million are included in discontinued operations at June 30, 2016, December 31, 2015, and June 30, 2015, respectively. See Note 11 (“Acquisitions and Discontinued Operations”) for further discussion.

(e)	Included in individually impaired loans allocated a specific allowance.

(f)	Included in allowance for individually evaluated impaired loans.

We evaluate purchased loans for impairment in accordance with the applicable accounting guidance. Purchased loans that have evidence of deterioration in credit quality since origination and for which it is probable, at acquisition, that all contractually required payments will not be collected are deemed PCI and initially recorded at fair value without recording an allowance for loan losses. All PCI loans were acquired in 2012. At the 2012 acquisition date, the estimated gross contractual amount receivable of all PCI loans totaled $41 million. The estimated cash flows not expected to be collected (the nonaccretable amount) were $11 million, and the accretable amount was approximately $5 million. The difference between the fair value and the cash flows expected to be collected from the purchased loans is accreted to interest income over the remaining term of the loans.

At June 30, 2016, the outstanding unpaid principal balance and carrying value of all PCI loans was $16 million and $11 million, respectively, compared to $17 million and $11 million, respectively, at December 31, 2015, and $18 million and $12 million, respectively, at June 30, 2015. Changes in the accretable yield during the first six months of 2016 included accretion and net reclassifications of less than $1 million, resulting in an ending balance of $5 million at June 30, 2016. Changes in the accretable yield during 2015 included accretion and net reclassifications of less than $1 million, resulting in an ending balance of $5 million at December 31, 2015, which was primarily unchanged from the ending balance at December 31, 2014, given that accretion and net reclassifications were less than $1 million during 2015. Changes in the accretable yield during the first six months of 2015 included accretion and net reclassifications of less than $1 million, resulting in an ending balance of $5 million at June 30, 2015.

At June 30, 2016, the approximate carrying amount of our commercial nonperforming loans outstanding represented 83% of their original contractual amount owed, total nonperforming loans outstanding represented 83% of their original contractual amount owed, and nonperforming assets in total were carried at 83% of their original contractual amount owed.

At June 30, 2016, our 20 largest nonperforming loans totaled $331 million, representing 54% of total loans on nonperforming status. At June 30, 2015, our 20 largest nonperforming loans totaled $120 million, representing 29% of total loans on nonperforming status.

Nonperforming loans and loans held for sale reduced expected interest income by $12 million for the six months ended June 30, 2016, and $8 million for the six months ended June 30, 2015.

The following tables set forth a further breakdown of individually impaired loans as of June 30, 2016, December 31, 2015, and June 30, 2015:


June 30, 2016 in millions	Recorded Investment ^(a)		Unpaid Principal Balance ^(b)		Specific Allowance		Average Recorded Investment
With no related allowance recorded:
Commercial, financial and agricultural	$	293	$	328		—	$	276
Commercial real estate:
Commercial mortgage		5		7		—		5
Construction		21		29		—		15

Total commercial real estate loans		26		36		—		20

Total commercial loans		319		364		—		296

Real estate — residential mortgage		22		22		—		23
Home equity loans		65		65		—		66
Consumer indirect loans		1		1		—		1

Total consumer loans		88		88		—		90

Total loans with no related allowance recorded		407		452		—		386

With an allowance recorded:
Commercial, financial and agricultural		29		30	$	16		65
Commercial real estate:
Commercial mortgage		—		—		—		2

Total commercial real estate loans		—		—		—		2

Total commercial loans		29		30		16		67

Real estate — residential mortgage		31		31		3		32
Home equity loans		66		66		20		65
Consumer direct loans		3		3		—		3
Credit cards		3		3		—		3
Consumer indirect loans		32		32		2		33

Total consumer loans		135		135		25		136

Total loans with an allowance recorded		164		165		41		203

Total	$	571	$	617	$	41	$	589

(a)	The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. This amount is a component of total loans on our consolidated balance sheet.

(b)	The Unpaid Principal Balance represents the customer’s legal obligation to us.


December 31, 2015 in millions	Recorded Investment ^(a)		Unpaid Principal Balance ^(b)		Specific Allowance		Average Recorded Investment
With no related allowance recorded:
Commercial, financial and agricultural	$	40	$	74		—	$	23
Commercial real estate:
Commercial mortgage		5		8		—		10
Construction		5		5		—		5

Total commercial real estate loans		10		13		—		15

Total commercial loans		50		87		—		38

Real estate — residential mortgage		23		23		—		24
Home equity loans		61		61		—		62
Consumer indirect loans		1		1		—		1

Total consumer loans		85		85		—		87

Total loans with no related allowance recorded		135		172		—		125
With an allowance recorded:
Commercial, financial and agricultural		28		43	$	7		33
Commercial real estate:
Commercial mortgage		5		6		1		6
Construction		—		—		—		1

Total commercial real estate loans		5		6		1		7

Total commercial loans		33		49		8		40

Real estate — residential mortgage		33		33		4		32
Home equity loans		64		64		20		60
Consumer direct loans		3		3		—		4
Credit cards		3		3		—		4
Consumer indirect loans		37		37		3		40

Total consumer loans		140		140		27		140

Total loans with an allowance recorded		173		189		35		180

Total	$	308	$	361	$	35	$	305

(a)	The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. This amount is a component of total loans on our consolidated balance sheet.

(b)	The Unpaid Principal Balance represents the customer’s legal obligation to us.


June 30, 2015 in millions	Recorded Investment ^(a)		Unpaid Principal Balance ^(b)		Specific Allowance		Average Recorded Investment
With no related allowance recorded:
Commercial, financial and agricultural	$	9	$	56		—	$	15
Commercial real estate:
Commercial mortgage		10		14		—		12
Construction		7		7		—		7

Total commercial real estate loans		17		21		—		19

Total commercial loans		26		77		—		34

Real estate — residential mortgage		22		22		—		22
Home equity loans		62		62		—		63
Consumer indirect loans		1		1		—		1

Total consumer loans		85		85		—		86

Total loans with no related allowance recorded		111		162		—		120
With an allowance recorded:
Commercial, financial and agricultural		73		86	$	24		67
Commercial real estate:
Commercial mortgage		6		7		1		6

Total commercial real estate loans		6		7		1		6

Total commercial loans		79		93		25		73

Real estate — residential mortgage		33		33		5		33
Home equity loans		63		63		19		62
Consumer direct loans		3		3		—		3
Credit cards		3		3		—		3
Consumer indirect loans		42		42		3		42

Total consumer loans		144		144		27		143

Total loans with an allowance recorded		223		237		52		216

Total	$	334	$	399	$	52	$	336

(a)	The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. This amount is a component of total loans on our consolidated balance sheet.

(b)	The Unpaid Principal Balance represents the customer’s legal obligation to us.

For the six months ended June 30, 2016, and June 30, 2015, interest income recognized on the outstanding balances of accruing impaired loans totaled $6 million and $3 million, respectively.

At June 30, 2016, aggregate restructured loans (accrual and nonaccrual loans) totaled $277 million, compared to $280 million at December 31, 2015, and $300 million at June 30, 2015. During the first six months of 2016, we added $49 million in restructured loans, which were offset by $52 million in payments and charge-offs. During 2015, we added $99 million in restructured loans, which were partially offset by $89 million in payments and charge-offs. During the first six months of 2015, we added $73 million in restructured loans, which were partially offset by $43 million in payments and charge-offs.

A further breakdown of TDRs included in nonperforming loans by loan category as of June 30, 2016, follows:


June 30, 2016 dollars in millions	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
LOAN TYPE
Nonperforming:
Commercial, financial and agricultural		14	$	50	$	32
Commercial real estate:
Real estate — commercial mortgage		8		2		1

Total commercial real estate loans		8		2		1

Total commercial loans		22		52		33
Real estate — residential mortgage		307		19		19
Home equity loans		1,332		86		76
Consumer direct loans		28		1		1
Credit cards		267		1		1
Consumer indirect loans		81		4		3

Total consumer loans		2,015		111		100

Total nonperforming TDRs		2,037		163		133
Prior-year accruing:^(a)
Commercial, financial and agricultural		6		30		20

Total commercial loans		6		30		20
Real estate — residential mortgage		536		35		35
Home equity loans		1,116		64		54
Consumer direct loans		39		2		2
Credit cards		478		3		2
Consumer indirect loans		415		59		31

Total consumer loans		2,584		163		124

Total prior-year accruing TDRs		2,590		193		144

Total TDRs		4,627	$	356	$	277

(a)	All TDRs that were restructured prior to January 1, 2016, and are fully accruing.

A further breakdown of TDRs included in nonperforming loans by loan category as of December 31, 2015, follows:


December 31, 2015 dollars in millions	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
LOAN TYPE
Nonperforming:
Commercial, financial and agricultural		12	$	56	$	45
Commercial real estate:
Real estate — commercial mortgage		12		30		7

Total commercial real estate loans		12		30		7

Total commercial loans		24		86		52
Real estate — residential mortgage		366		23		23
Home equity loans		1,262		85		76
Consumer direct loans		28		1		1
Credit cards		339		2		2
Consumer indirect loans		103		6		5

Total consumer loans		2,098		117		107

Total nonperforming TDRs		2,122		203		159
Prior-year accruing:^(a)
Commercial, financial and agricultural		7		5		2
Commercial real estate:
Real estate — commercial mortgage		—		—		—

Total commercial real estate loans		—		—		—

Total commercial loans		7		5		2
Real estate — residential mortgage		489		34		34
Home equity loans		1,071		57		49
Consumer direct loans		42		2		2
Credit cards		461		4		2
Consumer indirect loans		430		59		32

Total consumer loans		2,493		156		119

Total prior-year accruing TDRs		2,500		161		121

Total TDRs		4,622	$	364	$	280

(a)	All TDRs that were restructured prior to January 1, 2015, and are fully accruing.

A further breakdown of TDRs included in nonperforming loans by loan category as of June 30, 2015, follows:


June 30, 2015 dollars in millions	Number of Loans		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
LOAN TYPE
Nonperforming:
Commercial, financial and agricultural		12	$	74	$	58
Commercial real estate:
Real estate — commercial mortgage		12		32		8

Total commercial real estate loans		12		32		8

Total commercial loans		24		106		66
Real estate — residential mortgage		352		21		21
Home equity loans		1,193		80		73
Consumer direct loans		28		1		1
Credit cards		289		2		2
Consumer indirect loans		125		9		7

Total consumer loans		1,987		113		104

Total nonperforming TDRs		2,011		219		170
Prior-year accruing:^(a)
Commercial, financial and agricultural		14		6		3
Commercial real estate:
Real estate — commercial mortgage		1		2		1

Total commercial real estate loans		1		2		1

Total commercial loans		15		8		4
Real estate — residential mortgage		491		36		36
Home equity loans		1,138		58		50
Consumer direct loans		48		2		2
Credit cards		489		3		2
Consumer indirect loans		492		62		36

Total consumer loans		2,658		161		126

Total prior-year accruing TDRs		2,673		169		130

Total TDRs		4,684	$	388	$	300

(a)	All TDRs that were restructured prior to January 1, 2015, and are fully accruing.

We classify loan modifications as TDRs when a borrower is experiencing financial difficulties and we have granted a concession without commensurate financial, structural, or legal consideration. All commercial and consumer loan TDRs, regardless of size, are individually evaluated for impairment to determine the probable loss content and are assigned a specific loan allowance if deemed appropriate. This designation has the effect of moving the loan from the general reserve methodology (i.e., collectively evaluated) to the specific reserve methodology (i.e., individually evaluated) and may impact the ALLL through a charge-off or increased loan loss provision. These components affect the ultimate allowance level. Additional information regarding TDRs for discontinued operations is provided in Note 11 (“Acquisitions and Discontinued Operations”).

Commercial loan TDRs are considered defaulted when principal and interest payments are 90 days past due. Consumer loan TDRs are considered defaulted when principal and interest payments are more than 60 days past due. During the three months ended June 30, 2016, there were no commercial loan TDRs and 41 consumer loan TDRs with a combined recorded investment of $2 million that experienced payment defaults after modifications resulting in TDR status during 2015. During the three months ended June 30, 2015, there were no significant commercial loan TDRs and 65 consumer loan TDRs with a combined recorded investment of $3 million that experienced payment defaults from modifications resulting in TDR status during 2014. As TDRs are individually evaluated for impairment under the specific reserve methodology, subsequent defaults do not generally have a significant additional impact on the ALLL.

Our loan modifications are handled on a case-by-case basis and are negotiated to achieve mutually agreeable terms that maximize loan collectability and meet the borrower’s financial needs. Our concession types are primarily interest rate reductions, forgiveness of principal, and other modifications. The commercial TDR other concession category includes modification of loan terms, covenants, or conditions. The consumer TDR other concession category primarily includes those borrowers’ debts that are discharged through Chapter 7 bankruptcy and have not been formally re-affirmed.

The following table shows the post-modification outstanding recorded investment by concession type for our commercial and consumer accruing and nonaccruing TDRs and other selected financial data.


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Commercial loans:
Interest rate reduction	$	52	$	51	$	60
Forgiveness of principal		—		2		2
Other		1		1		8

Total	$	53	$	54	$	70

Consumer loans:
Interest rate reduction	$	128	$	132	$	142
Forgiveness of principal		3		8		4
Other		93		86		84

Total	$	224	$	226	$	230

Total commercial and consumer TDRs^(a)	$	277	$	280	$	300
Total loans		62,098		59,876		58,264

(a)	Commitments outstanding to lend additional funds to borrowers whose loan terms have been modified in TDRs are $7 million, $9 million, and $8 million at June 30, 2016, December 31, 2015, and June 30, 2015, respectively.

Our policies for determining past due loans, placing loans on nonaccrual, applying payments on nonaccrual loans, and resuming accrual of interest for our commercial and consumer loan portfolios are disclosed in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Nonperforming Loans” beginning on page 121 of our 2015 Form 10-K.

At June 30, 2016, approximately $61.2 billion, or 98.5%, of our total loans were current, compared to approximately $59.2 billion, or 98.9% of total loans, at December 31, 2015, and approximately $57.6 billion, or 98.8% of total loans, at June 30, 2015. At June 30, 2016, total past due loans and nonperforming loans of $892 million represented approximately 1.4% of total loans, compared to $667 million, or 1.1% of total loans, at December 31, 2015, and $666 million, or 1.2% of total loans, at June 30, 2015.

The following aging analysis of past due and current loans as of June 30, 2016, December 31, 2015, and June 30, 2015, provides further information regarding Key’s credit exposure.


June 30, 2016 in millions	Current		30-59 Days Past Due		60-89 Days Past Due		90 and Greater Days Past Due		Nonperforming Loans		Total Past Due and Nonperforming Loans		Purchased Credit Impaired		Total Loans
LOAN TYPE
Commercial, financial and agricultural	$	32,975	$	46	$	10	$	24	$	321	$	401		—	$	33,376
Commercial real estate:
Commercial mortgage		8,556		4		1		7		14		26		—		8,582
Construction		854		—		—		2		25		27		—		881

Total commercial real estate loans		9,410		4		1		9		39		53		—		9,463
Commercial lease financing		3,939		22		6		11		10		49		—		3,988

Total commercial loans	$	46,324	$	72	$	17	$	44	$	370	$	503		—	$	46,827

Real estate — residential mortgage	$	2,208	$	9	$	3	$	1	$	54	$	67	$	10	$	2,285
Home equity loans		9,799		36		25		12		189		262		1		10,062
Consumer direct loans		1,557		18		3		5		1		27		—		1,584
Credit cards		796		5		3		7		2		17		—		813
Consumer indirect loans		511		9		3		1		3		16		—		527

Total consumer loans	$	14,871	$	77	$	37	$	26	$	249	$	389	$	11	$	15,271

Total loans	$	61,195	$	149	$	54	$	70	$	619	$	892	$	11	$	62,098


December 31, 2015 in millions	Current		30-59 Days Past Due		60-89 Days Past Due		90 and Greater Days Past Due		Nonperforming Loans		Total Past Due and Nonperforming Loans		Purchased Credit Impaired		Total Loans
LOAN TYPE
Commercial, financial and agricultural	$	31,116	$	11	$	11	$	20	$	82	$	124		—	$	31,240
Commercial real estate:
Commercial mortgage		7,917		8		5		10		19		42		—		7,959
Construction		1,042		1		1		—		9		11		—		1,053

Total commercial real estate loans		8,959		9		6		10		28		53		—		9,012
Commercial lease financing		3,952		33		11		11		13		68		—		4,020

Total commercial loans	$	44,027	$	53	$	28	$	41	$	123	$	245		—	$	44,272

Real estate — residential mortgage	$	2,149	$	14	$	3	$	2	$	64	$	83	$	10	$	2,242
Home equity loans		10,056		50		24		14		190		278		1		10,335
Consumer direct loans		1,580		10		3		5		2		20		—		1,600
Credit cards		785		6		4		9		2		21		—		806
Consumer indirect loans		601		9		4		1		6		20		—		621

Total consumer loans	$	15,171	$	89	$	38	$	31	$	264	$	422	$	11	$	15,604

Total loans	$	59,198	$	142	$	66	$	72	$	387	$	667	$	11	$	59,876


June 30, 2015 in millions	Current		30-59 Days Past Due		60-89 Days Past Due		90 and Greater Days Past Due		Nonperforming Loans		Total Past Due and Nonperforming Loans		Purchased Credit Impaired		Total Loans
LOAN TYPE
Commercial, financial and agricultural	$	29,137	$	26	$	5	$	17	$	100	$	148		—	$	29,285
Commercial real estate:
Commercial mortgage		7,823		6		2		17		26		51		—		7,874
Construction		1,242		—		—		—		12		12		—		1,254

Total commercial real estate loans		9,065		6		2		17		38		63		—		9,128
Commercial lease financing		3,967		20		3		2		18		43		—		4,010

Total commercial loans	$	42,169	$	52	$	10	$	36	$	156	$	254		—	$	42,423

Real estate — residential mortgage	$	2,155	$	13	$	3	$	3	$	67	$	86	$	11	$	2,252
Home equity loans		10,264		47		24		12		184		267		1		10,532
Consumer direct loans		1,577		8		3		6		1		18		—		1,595
Credit cards		735		5		3		8		2		18		—		753
Consumer indirect loans		686		10		3		1		9		23		—		709

Total consumer loans	$	15,417	$	83	$	36	$	30	$	263	$	412	$	12	$	15,841

Total loans	$	57,586	$	135	$	46	$	66	$	419	$	666	$	12	$	58,264

The prevalent risk characteristic for both commercial and consumer loans is the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms. Evaluation of this risk is stratified and monitored by the loan risk rating grades assigned for the commercial loan portfolios and the regulatory risk ratings assigned for the consumer loan portfolios.

Most extensions of credit are subject to loan grading or scoring. Loan grades are assigned at the time of origination, verified by credit risk management, and periodically re-evaluated thereafter. This risk rating methodology blends our judgment with quantitative modeling. Commercial loans generally are assigned two internal risk ratings. The first rating reflects the probability that the borrower will default on an obligation; the second rating reflects expected recovery rates on the credit facility. Default probability is determined based on, among other factors, the financial strength of the borrower, an assessment of the borrower’s management, the borrower’s competitive position within its industry sector, and our view of industry risk in the context of the general economic outlook. Types of exposure, transaction structure, and collateral, including credit risk mitigants, affect the expected recovery assessment.

Credit quality indicators for our commercial and consumer loan portfolios, excluding $11 million, $11 million, and $12 million of PCI loans at June 30, 2016, December 31, 2015, and June 30, 2015, respectively, based on regulatory classification and payment activity as of June 30, 2016, December 31, 2015, and June 30, 2015, are as follows:

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category^(a)(b)


in millions
	Commercial, financial and agricultural						RE — Commercial						RE — Construction
	June 30,		December 31,		June 30,		June 30,		December 31,		June 30,		June 30,		December 31,		June 30,
RATING	2016		2015		2015		2016		2015		2015		2016		2015		2015
Pass	$	31,700	$	29,921	$	28,169	$	8,380	$	7,800	$	7,603	$	831	$	1,007	$	1,222
Criticized (Accruing)		1,354		1,236		1,015		188		139		245		25		37		20
Criticized (Nonaccruing)		322		83		101		14		20		26		25		9		12

Total	$	33,376	$	31,240	$	29,285	$	8,582	$	7,959	$	7,874	$	881	$	1,053	$	1,254


	Commercial Lease						Total
	June 30,		December 31,		June 30,		June 30,		December 31,		June 30,
RATING	2016		2015		2015		2016		2015		2015
Pass	$	3,932	$	3,967	$	3,944	$	44,843	$	42,695	$	40,938
Criticized (Accruing)		46		38		48		1,613		1,450		1,328
Criticized (Nonaccruing)		10		15		18		371		127		157

Total	$	3,988	$	4,020	$	4,010	$	46,827	$	44,272	$	42,423

(a)	Credit quality indicators are updated on an ongoing basis and reflect credit quality information as of the dates indicated.

(b)

The term criticized refers to those loans that are internally classified by Key as special mention or worse, which are asset quality categories defined by regulatory authorities. These assets have an elevated level of risk and may have a high probability of default or total loss. Pass rated refers to all loans not classified as criticized.

Consumer Credit Exposure

Credit Risk Profile by Regulatory Classifications^(a)(b)


in millions
	Residential — Prime
	June 30,		December 31,		June 30,
GRADE	2016		2015		2015
Pass	$	12,080	$	12,296	$	12,506
Substandard		256		270		266

Total	$	12,336	$	12,566	$	12,772

Credit Risk Profile Based on Payment Activity^(a)


in millions
	Consumer direct loans						Credit cards						Consumer indirect loans
	June 30,		December 31,		June 30,		June 30,		December 31,		June 30,		June 30,		December 31,		June 30,
	2016		2015		2015		2016		2015		2015		2016		2015		2015
Performing	$	1,583	$	1,598	$	1,594	$	811	$	804	$	751	$	524	$	615	$	700
Nonperforming		1		2		1		2		2		2		3		6		9

Total	$	1,584	$	1,600	$	1,595	$	813	$	806	$	753	$	527	$	621	$	709


	Total
	June 30,		December 31,		June 30,
	2016		2015		2015
Performing	$	2,918	$	3,017	$	3,045
Nonperforming		6		10		12

Total	$	2,924	$	3,027	$	3,057

(a)	Credit quality indicators are updated on an ongoing basis and reflect credit quality information as of the dates indicated.

(b)	Our past due payment activity to regulatory classification conversion is as follows: pass = less than 90 days; and substandard = 90 days and greater plus nonperforming loans.

We determine the appropriate level of the ALLL on at least a quarterly basis. The methodology is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses” beginning on page 122 of our 2015 Form 10-K. We apply expected loss rates to existing loans with similar risk characteristics as noted in the credit quality indicator table above and exercise judgment to assess the impact of qualitative factors such as changes in economic conditions, changes in credit policies or underwriting standards, and changes in the level of credit risk associated with specific industries and markets.

less costs to sell. Non-Chapter 7 consumer loan TDRs are combined in homogenous pools and assigned a specific allocation based on the estimated present value of future cash flows using the loan’s effective interest rate. A specific allowance also may be assigned — even when sources of repayment appear sufficient — if we remain uncertain about whether the loan will be repaid in full. On at least a quarterly basis, we evaluate the appropriateness of our loss estimation methods to reduce differences between estimated incurred losses and actual losses. The ALLL at June 30, 2016, represents our best estimate of the probable credit losses inherent in the loan portfolio at that date.

Commercial loans generally are charged off in full or charged down to the fair value of the underlying collateral when the borrower’s payment is 180 days past due. Consumer loans generally are charged off when payments are 120 days past due. Home equity and residential mortgage loans generally are charged down to net realizable value when payment is 180 days past due. Credit card loans and similar unsecured products are charged off when payments are 180 days past due.

At June 30, 2016, the ALLL was $854 million, or 1.38% of loans, compared to $796 million, or 1.37% of loans, at June 30, 2015. At June 30, 2016, the ALLL was 138% of nonperforming loans, compared to 190% at June 30, 2015.

A summary of the changes in the ALLL for the periods indicated is presented in the table below:


	Three months ended June 30,						Six months ended June 30,
in millions	2016			2015			2016			2015
Balance at beginning of period — continuing operations	$	826		$	794		$	796		$	794
Charge-offs		(64	)		(52	)		(124	)		(99	)
Recoveries		21			16			35			35

Net loans and leases charged off		(43	)		(36	)		(89	)		(64	)
Provision for loan and lease losses from continuing operations		71			37			147			66
Foreign currency translation adjustment		—			1			—			—

Balance at end of period — continuing operations	$	854		$	796		$	854		$	796

The changes in the ALLL by loan category for the periods indicated are as follows:


in millions	December 31, 2015		Provision			Charge-offs			Recoveries		June 30, 2016
Commercial, financial and agricultural	$	450	$	118		$	(61	)	$	6	$	513
Real estate — commercial mortgage		134		(4	)		(3	)		8		135
Real estate — construction		25		(9	)		—			1		17
Commercial lease financing		47		2			(6	)		2		45

Total commercial loans		656		107			(70	)		17		710
Real estate — residential mortgage		18		1			(3	)		2		18
Home equity loans		57		18			(17	)		7		65
Consumer direct loans		20		8			(12	)		3		19
Credit cards		32		12			(16	)		2		30
Consumer indirect loans		13		1			(6	)		4		12

Total consumer loans		140		40			(54	)		18		144

Total ALLL — continuing operations		796		147	^(a)		(124	)		35		854
Discontinued operations		28		2			(15	)		5		20

Total ALLL — including discontinued operations	$	824	$	149		$	(139	)	$	40	$	874

(a)	Excludes a credit for losses on lending-related commitments of $6 million.


in millions	December 31, 2014		Provision			Charge-offs			Recoveries		June 30, 2015
Commercial, financial and agricultural	$	391	$	49		$	(33	)	$	11	$	418
Real estate — commercial mortgage		148		(4	)		(2	)		2		144
Real estate — construction		28		3			(1	)		1		31
Commercial lease financing		56		(5	)		(3	)		5		53

Total commercial loans		623		43			(39	)		19		646
Real estate — residential mortgage		23		(1	)		(3	)		1		20
Home equity loans		71		3			(18	)		5		61
Consumer direct loans		22		7			(12	)		4		21
Credit cards		33		13			(16	)		1		31
Consumer indirect loans		22		1			(11	)		5		17

Total consumer loans		171		23			(60	)		16		150

Total ALLL — continuing operations		794		66	^(a)		(99	)		35		796
Discontinued operations		29		1			(16	)		8		22

Total ALLL — including discontinued operations	$	823	$	67		$	(115	)	$	43	$	818

(a)	Excludes provision for losses on lending-related commitments of $10 million.

Our ALLL from continuing operations increased by $58 million, or 7.3%, from the second quarter of 2015. Our allowance applies expected loss rates to our existing loans with similar risk characteristics as well as any adjustments to reflect our current assessment of qualitative factors, such as changes in economic conditions, underwriting standards, and concentrations of credit. Our commercial ALLL increased by $64 million, or 9.9%, from the second quarter of 2015 primarily because of loan growth and increased incurred loss estimates. The increase in these incurred loss estimates during 2015 and into 2016 was primarily due to the continued decline in oil and gas prices since 2014. Partially offsetting this increase was a decrease in our consumer ALLL of $6 million, or 4%, from the second quarter of 2015. Our consumer ALLL decrease was primarily due to continued improvement in credit metrics, such as delinquency, average credit bureau score, and loan to value, which have decreased expected loss rates since 2014. The continued improvement in the consumer portfolio credit quality metrics from the second quarter of 2015 was primarily due to continued improved credit quality and benefits of relatively stable economic conditions.

For continuing operations, the loans outstanding individually evaluated for impairment totaled $571 million, with a corresponding allowance of $41 million at June 30, 2016. Loans outstanding collectively evaluated for impairment totaled $61.5 billion, with a corresponding allowance of $812 million at June 30, 2016. At June 30, 2016, PCI loans evaluated for impairment totaled $11 million, with a corresponding allowance of $1 million. There was no provision for loan and lease losses on these PCI loans during the six months ended June 30, 2016. At June 30, 2015, the loans outstanding individually evaluated for impairment totaled $334 million, with a corresponding allowance of $52 million. Loans outstanding collectively evaluated for impairment totaled $57.9 billion, with a corresponding allowance of $743 million at June 30, 2015. At June 30, 2015, PCI loans evaluated for impairment totaled $12 million, with a corresponding allowance of $1 million. There was no provision for loan and lease losses on these PCI loans during the six months ended June 30, 2015.

A breakdown of the individual and collective ALLL and the corresponding loan balances as of June 30, 2016, follows:


	Allowance						Outstanding
June 30, 2016 in millions	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Purchased Credit Impaired		Loans			Individually Evaluated for Impairment		Collectively Evaluated for Impairment			Purchased Credit Impaired
Commercial, financial and agricultural	$	16	$	497		—	$	33,376		$	322	$	33,054			—
Commercial real estate:
Commercial mortgage		—		135		—		8,582			5		8,577			—
Construction		—		17		—		881			21		860			—

Total commercial real estate loans		—		152		—		9,463			26		9,437			—
Commercial lease financing		—		45		—		3,988			—		3,988			—

Total commercial loans		16		694		—		46,827			348		46,479			—
Real estate — residential mortgage		3		14	$	1		2,285			53		2,222		$	10
Home equity loans		20		45		—		10,062			131		9,930			1
Consumer direct loans		—		19		—		1,584			3		1,581			—
Credit cards		—		30		—		813			3		810			—
Consumer indirect loans		2		10		—		527			33		494			—

Total consumer loans		25		118		1		15,271			223		15,037			11

Total ALLL — continuing operations		41		812		1		62,098			571		61,516			11
Discontinued operations		2		18		—		1,692	^(a)		22		1,670	^(a)		—

Total ALLL — including discontinued operations	$	43	$	830	$	1	$	63,790		$	593	$	63,186		$	11

(a)	Amount includes $3 million of loans carried at fair value that are excluded from ALLL consideration.

A breakdown of the individual and collective ALLL and the corresponding loan balances as of December 31, 2015, follows:


	Allowance						Outstanding
December 31, 2015 in millions	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Purchased Credit Impaired		Loans			Individually Evaluated for Impairment		Collectively Evaluated for Impairment			Purchased Credit Impaired
Commercial, financial and agricultural	$	7	$	443		—	$	31,240		$	68	$	31,172			—
Commercial real estate:
Commercial mortgage		1		133		—		7,959			10		7,949			—
Construction		—		25		—		1,053			5		1,048			—

Total commercial real estate loans		1		158		—		9,012			15		8,997			—
Commercial lease financing		—		47		—		4,020			—		4,020			—

Total commercial loans		8		648		—		44,272			83		44,189			—
Real estate — residential mortgage		4		13	$	1		2,242			56		2,176		$	10
Home equity loans		20		37		—		10,335			125		10,209			1
Consumer direct loans		—		20		—		1,600			3		1,597			—
Credit cards		—		32		—		806			3		803			—
Consumer indirect loans		3		10		—		621			38		583			—

Total consumer loans		27		112		1		15,604			225		15,368			11

Total ALLL — continuing operations		35		760		1		59,876			308		59,557			11
Discontinued operations		2		26		—		1,828	^(a)		21		1,807	^(a)		—

Total ALLL — including discontinued operations	$	37	$	786	$	1	$	61,704		$	329	$	61,364		$	11

(a)	Amount includes $4 million of loans carried at fair value that are excluded from ALLL consideration.

A breakdown of the individual and collective ALLL and the corresponding loan balances as of June 30, 2015, follows:


	Allowance						Outstanding
June 30, 2015 in millions	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Purchased Credit Impaired		Loans		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Purchased Credit Impaired
Commercial, financial and agricultural	$	24	$	394		—	$	29,285	$	82	$	29,203		—
Commercial real estate:
Commercial mortgage		1		143		—		7,874		16		7,858		—
Construction		—		31		—		1,254		7		1,247		—

Total commercial real estate loans		1		174		—		9,128		23		9,105		—
Commercial lease financing		—		53		—		4,010		—		4,010		—

Total commercial loans		25		621		—		42,423		105		42,318		—
Real estate — residential mortgage		5		14	$	1		2,252		56		2,185	$	11
Home equity loans		19		42		—		10,532		124		10,407		1
Consumer direct loans		—		21		—		1,595		3		1,592		—
Credit cards		—		31		—		753		3		750		—
Consumer indirect loans		3		14		—		709		43		666		—

Total consumer loans		27		122		1		15,841		229		15,600		12

Total ALLL — continuing operations		52		743		1		58,264		334		57,918		12
Discontinued operations		1		21		—		1,962		19		1,943		—

Total ALLL — including discontinued operations	$	53	$	764	$	1	$	60,226	$	353	$	59,861	$	12

The liability for credit losses inherent in lending-related unfunded commitments, such as letters of credit and unfunded loan commitments, is included in “accrued expense and other liabilities” on the balance sheet. We establish the amount of this reserve by considering both historical trends and current market conditions quarterly, or more often if deemed necessary. Our liability for credit losses on lending-related commitments was $50 million at June 30, 2016. When combined with our ALLL, our total allowance for credit losses represented 1.46% of loans at June 30, 2016, compared to 1.44% at June 30, 2015.

Changes in the liability for credit losses on unfunded lending-related commitments are summarized as follows:


	Three months ended June 30,					Six months ended June 30,
in millions	2016			2015		2016			2015
Balance at beginning of period	$	69		$	41	$	56		$	35
Provision (credit) for losses on lending-related commitments		(19	)		4		(6	)		10

Balance at end of period	$	50		$	45	$	50		$	45

5. Fair Value Measurements

Fair Value Determination

As defined in the applicable accounting guidance, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in our principal market. We have established and documented our process for determining the fair values of our assets and liabilities, where applicable. Fair value is based on quoted market prices, when available, for identical or similar assets or liabilities. In the absence of quoted market prices, we determine the fair value of our assets and liabilities using valuation models or third-party pricing services. Both of these approaches rely on market-based parameters, when available, such as interest rate yield curves, option volatilities, and credit spreads, or unobservable inputs. Unobservable inputs may be based on our judgment, assumptions, and estimates related to credit quality, liquidity, interest rates, and other relevant inputs.

Valuation adjustments, such as those pertaining to counterparty and our 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 does not accurately reflect the counterparty’s or our own credit quality. We make liquidity valuation adjustments to the fair value of certain assets to reflect the uncertainty in the pricing and trading of the instruments when we are unable to observe recent market transactions for identical or similar instruments. Liquidity valuation adjustments are based on the following factors:

•

the amount of time since the last relevant valuation;

•

whether there is an actual trade or relevant external quote available at the measurement date; and

•

volatility associated with the primary pricing components.

We ensure that our fair value measurements are accurate and appropriate by relying upon various controls, including:

•

an independent review and approval of valuation models and assumptions;

•

recurring detailed reviews of profit and loss; and

•

a validation of valuation model components against benchmark data and similar products, where possible.

We recognize transfers between levels of the fair value hierarchy at the end of the reporting period. Quarterly, we review any changes to our valuation methodologies to ensure they are appropriate and justified, and refine our valuation methodologies if more market-based data becomes available. The Fair Value Committee, which is governed by ALCO, oversees the valuation process. Various Working Groups that report to the Fair Value Committee analyze and approve the underlying assumptions and valuation adjustments. Changes in valuation methodologies for Level 1 and Level 2 instruments are presented to the Accounting Policy group for approval. Changes in valuation methodologies for Level 3 instruments are presented to the Fair Value Committee for approval. The Working Groups are discussed in more detail in the qualitative disclosures within this note and in Note 11 (“Acquisitions and Discontinued Operations”). Formal documentation of the fair valuation methodologies is prepared by the lines of business and support areas as appropriate. The documentation details the asset or liability class and related general ledger accounts, valuation techniques, fair value hierarchy level, market participants, accounting methods, valuation methodology, group responsible for valuations, and valuation inputs.

Additional information regarding our accounting policies for determining fair value is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Fair Value Measurements” beginning on page 124 of our 2015 Form 10-K.

Qualitative Disclosures of Valuation Techniques

Loans. Most loans recorded as trading account assets are valued based on market spreads for similar assets since they are actively traded. Therefore, these loans are classified as Level 2 because the fair value recorded is based on observable market data for similar assets.

Securities (trading and available for sale). We own several types of securities, requiring a range of valuation methods:

•

Securities are classified as Level 1 when quoted market prices are available in an active market for the identical securities. Level 1 instruments include exchange-traded equity securities.

•

Securities are classified as Level 2 if quoted prices for identical securities are not available, and fair value is determined using pricing models (either by a third-party pricing service or internally) or quoted prices of similar securities. These instruments include municipal bonds; bonds backed by the U.S. government; corporate bonds; certain mortgage-backed securities; securities issued by the U.S. Treasury; money markets; and certain agency and corporate CMOs. Inputs to the pricing models include: standard inputs, such as yields, benchmark securities, bids, and offers; actual trade data (i.e., spreads, credit ratings, and interest rates) for comparable assets; spread tables; matrices; high-grade scales; and option-adjusted spreads.

•

Securities are classified as Level 3 when there is limited activity in the market for a particular instrument. To determine fair value in such cases, depending on the complexity of the valuations required, we use internal models based on certain assumptions or a third-party valuation service. At June 30, 2016, our Level 3 instruments consist of two convertible preferred securities. Our Strategy group is responsible for reviewing the valuation model and determining the fair value of these investments on a quarterly basis. The securities are valued using a cash flow analysis of the associated private company issuers. The valuations of the securities are negatively impacted by projected net losses of the associated private companies and positively impacted by projected net gains.

The fair values of our Level 2 securities available for sale are determined by a third-party pricing service. The valuations provided by the third-party pricing service are based on observable market inputs, which include benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers, and reference data obtained from market research publications. Inputs used by the third-party pricing service in valuing CMOs and other mortgage-backed securities also include new issue data, monthly payment information, whole loan collateral performance, and “To Be Announced” prices. In valuations of securities issued by state and political subdivisions, inputs used by the third-party pricing service also include material event notices.

On a monthly basis, we validate the pricing methodologies utilized by our third-party pricing service to ensure the fair value determination is consistent with the applicable accounting guidance and that our assets are properly classified in the fair value hierarchy. To perform this validation, we:

•

review documentation received from our third-party pricing service regarding the inputs used in their valuations and determine a level assessment for each category of securities;

•

substantiate actual inputs used for a sample of securities by comparing the actual inputs used by our third-party pricing service to comparable inputs for similar securities; and

•

substantiate the fair values determined for a sample of securities by comparing the fair values provided by our third-party pricing service to prices from other independent sources for the same and similar securities. We analyze variances and conduct additional research with our third-party pricing service and take appropriate steps based on our findings.

Private equity and mezzanine investments. Private equity and mezzanine investments consist of investments in debt and equity securities through our Real Estate Capital line of business. They include direct investments made in specific properties, as well as indirect investments made in funds that pool assets of many investors to invest in properties. There is no active market for these investments, so we employ other valuation methods. The portion of our Real Estate Capital line of business involved with private equity and mezzanine investments is accounted for as an investment company in accordance with the applicable accounting guidance, whereby all investments are recorded at fair value.

Direct private equity and mezzanine investments are classified as Level 3 assets since our judgment significantly influences the determination of fair value. Our Fund Management, Asset Management, and Accounting groups are responsible for reviewing the valuation models and determining the fair value of these investments on a quarterly basis. Direct investments in properties are initially valued based upon the transaction price. This amount is then adjusted to fair value based on current market conditions using the discounted cash flow method based on the expected investment exit date. The fair values of the assets are reviewed and adjusted quarterly. There were no significant direct equity and mezzanine investments at June 30, 2016, and June 30, 2015.

The fair value of our indirect investments is based on the most recent value of the capital accounts as reported by the general partners of the funds in which we invest. The calculation to determine the investment’s fair value is based on our percentage

ownership in the fund multiplied by the net asset value of the fund, as provided by the fund manager. Under the requirements of the Volcker Rule, we will be required to dispose of some or all of our indirect investments. The Federal Reserve extended the conformance period to July 21, 2017, for all banking entities with respect to covered funds. Key is permitted to file for an additional extension of up to five years for illiquid funds, to retain the indirect investments for a longer period of time. We plan to continue to evaluate our options, including applying for the extension and holding the investments. As of June 30, 2016, management has not committed to a plan to sell these investments. Therefore, these investments continue to be valued using the net asset value per share methodology. For more information about the Volcker Rule, see the discussion under the heading “Other Regulatory Developments under the Dodd-Frank Act — ‘Volcker Rule’” in the section entitled “Supervision and Regulation” beginning on page 17 of our 2015 Form 10-K.

Investments in real estate private equity funds are included within private equity and mezzanine investments. The main purpose of these funds is to acquire a portfolio of real estate investments that provides attractive risk-adjusted returns and current income for investors. Certain of these investments do not have readily determinable fair values and represent our ownership interest in an entity that follows measurement principles under investment company accounting.

The following table presents the fair value of our indirect investments and related unfunded commitments at June 30, 2016. We did not provide any financial support to investees related to our direct and indirect investments for the six months ended June 30, 2016, and June 30, 2015.


June 30, 2016 in millions	Fair Value		Unfunded Commitments
INVESTMENT TYPE
Indirect investments
Passive funds^(a)	$	8	$	1

Total	$	8	$	1

(a)

We invest in passive funds, which are multi-investor private equity funds. These investments can never be redeemed. Instead, distributions are received through the liquidation of the underlying investments in the funds. Some funds have no restrictions on sale, while others require investors to remain in the fund until maturity. The funds will be liquidated over a period of one to three years. The purpose of KREEC’s funding is to allow funds to make additional investments and keep a certain market value threshold in the funds. KREEC is obligated to provide financial support, as all investors are required, to the funds based on its ownership percentage, as noted in the Limited Partnership Agreements.

Principal investments. Principal investments consist of investments in equity and debt instruments made by our principal investing entities. They include direct investments (investments made in a particular company) and indirect investments (investments made through funds that include other investors). Our principal investing entities are accounted for as investment companies in accordance with the applicable accounting guidance, whereby each investment is adjusted to fair value with any net realized or unrealized gain/loss recorded in the current period’s earnings. This process is a coordinated and documented effort by the Principal Investing Entities Deal Team (individuals from one of the independent investment managers who oversee these instruments), accounting staff, and the Investment Committee (individual employees and a former employee of Key and one of the independent investment managers). This process involves an in-depth review of the condition of each investment depending on the type of investment.

Our direct investments include investments in debt and equity instruments of both private and public companies. When quoted prices are available in an active market for the identical direct investment, we use the quoted prices in the valuation process, and the related investments are classified as Level 1 assets. As of December 31, 2015, the valuation of our Level 2 investment included a quoted price, which was adjusted by liquidity assumptions due to a contractual term of the investment. The contractual term expired and this investment was transferred from Level 2 to Level 1 as of March 31, 2016. In most cases, quoted market prices are not available for our direct investments, and we must perform valuations using other methods. These direct investment valuations are an in-depth analysis of the condition of each investment and are based on the unique facts and circumstances related to each individual investment. There is a certain amount of subjectivity surrounding the valuation of these investments due to the combination of quantitative and qualitative factors that are used in the valuation models. Therefore, these direct investments are classified as Level 3 assets. The specific inputs used in the valuations of each type of direct investment are described below.

Interest-bearing securities (i.e., loans) are valued on a quarterly basis. Valuation adjustments are determined by the Principal Investing Entities Deal Team and are subject to approval by the Investment Committee. Valuations of debt instruments are based on the Principal Investing Entities Deal Team’s knowledge of the current financial status of the subject company, which is regularly monitored throughout the term of the investment. Significant unobservable inputs used in the valuations of these investments include the company’s payment history, adequacy of cash flows from operations, and current operating

results, including market multiples and historical and forecast EBITDA. Inputs can also include the seniority of the debt, the nature of any pledged collateral, the extent to which the security interest is perfected, and the net liquidation value of collateral.

Valuations of equity instruments of private companies, which are prepared on a quarterly basis, are based on current market conditions and the current financial status of each company. A valuation analysis is performed to value each investment. The valuation analysis is reviewed by the Principal Investing Entities Deal Team Member, and reviewed and approved by the Chief Administrative Officer of one of the independent investment managers. Significant unobservable inputs used in these valuations include adequacy of the company’s cash flows from operations, any significant change in the company’s performance since the prior valuation, and any significant equity issuances by the company. Equity instruments of public companies are valued using quoted prices in an active market for the identical security. If the instrument is restricted, the fair value is determined considering the number of shares traded daily, the number of the company’s total restricted shares, and price volatility.

Our indirect investments include primary and secondary investments in private equity funds engaged mainly in venture- and growth-oriented investing. These investments do not have readily determinable fair values. Indirect investments are valued using a methodology that is consistent with accounting guidance that allows us to estimate fair value based upon net asset value per share (or its equivalent, such as member units or an ownership interest in partners’ capital to which a proportionate share of net assets is attributed). Under the requirements of the Volcker Rule, we will be required to dispose of some or all of our indirect investments. At June 30, 2016, management has not committed to a plan to sell these investments. Therefore, these investments continue to be valued using the net asset value per share methodology.

For indirect investments, management may make adjustments it deems appropriate to the net asset value if it is determined that the net asset value does not properly reflect fair value. In determining the need for an adjustment to net asset value, management performs an analysis of the private equity funds based on the independent fund manager’s valuations as well as management’s own judgment. Management also considers whether the independent fund manager adequately marks down an impaired investment, maintains financial statements in accordance with GAAP, or follows a practice of holding all investments at cost.

The following table presents the fair value of our direct and indirect principal investments and related unfunded commitments at June 30, 2016, as well as financial support provided for the six months ended June 30, 2016, and June 30, 2015.


					Financial support provided
					Three months ended June 30,								Six months ended June 30,
	June 30, 2016				2016				2015				2016				2015
in millions	Fair Value		Unfunded Commitments		Funded Commitments		Funded Other		Funded Commitments		Funded Other		Funded Commitments		Funded Other		Funded Commitments		Funded Other
INVESTMENT TYPE
Direct investments^(a)	$	40		—		—		—		—		—		—	$	13		—	$	2
Indirect investments^(b) (measured at NAV)		184	$	44	$	2		—	$	3		—	$	3		—	$	5		—

Total	$	224	$	44	$	2		—	$	3		—	$	3	$	13	$	5	$	2

(a)

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

(b)

Our indirect investments consist of buyout funds, venture capital funds, and fund of funds. These investments are generally not redeemable. Instead, distributions are received through the liquidation of the underlying investments of the fund. An investment in any one of these funds typically can be sold only with the approval of the fund’s general partners. We estimate that the underlying investments of the funds will be liquidated over a period of one to eight years. The purpose of funding our capital commitments to these investments is to allow the funds to make additional follow-on investments and pay fund expenses until the fund dissolves. We, and all other investors in the fund, are obligated to fund the full amount of our respective capital commitments to the fund based on our and their respective ownership percentages, as noted in the applicable Limited Partnership Agreement.

Other. We had one indirect equity investment in the form of limited partnership units representing less than a five percent ownership interest in the entity’s equity. The fair value of this investment was based upon the NAV accounting methodology. Under the requirements of the Volcker Rule, we were required to dispose of this investment. Prior to December 31, 2015, this investment was redeemed.

Derivatives. Exchange-traded derivatives are valued using quoted prices and, therefore, are classified as Level 1 instruments. However, only a few types of derivatives are exchange-traded. The majority of our derivative positions are valued using internally developed models based on market convention that use observable market inputs, such as interest rate curves, yield curves, LIBOR and Overnight Index Swap (OIS) discount rates and curves, index pricing curves, foreign currency curves, and volatility surfaces (a three-dimensional graph of implied volatility against strike price and maturity). These derivative contracts, which are classified as Level 2 instruments, include interest rate swaps, certain options, cross currency swaps, and credit default swaps.

In addition, we have several customized derivative instruments and risk participations that are classified as Level 3 instruments. These derivative positions are valued using internally developed models, with inputs consisting of available market data, such as bond spreads and asset values, as well as unobservable internally derived assumptions, such as loss probabilities and internal risk ratings of customers. These derivatives are priced monthly by our MRM group using a credit valuation adjustment methodology. Swap details with the customer and our related participation percentage, if applicable, are obtained from our derivatives accounting system, which is the system of record. Applicable customer rating information is obtained from the particular loan system and represents an unobservable input to this valuation process. Using these various inputs, a valuation of these Level 3 derivatives is performed using a model that was acquired from a third party. In summary, the fair value represents an estimate of the amount that the risk participation counterparty would need to pay/receive as of the measurement date based on the probability of customer default on the swap transaction and the fair value of the underlying customer swap. Therefore, a higher loss probability and a lower credit rating would negatively affect the fair value of the risk participations and a lower loss probability and higher credit rating would positively affect the fair value of the risk participations.

Market convention implies a credit rating of “AA” equivalent in the pricing of derivative contracts, which assumes all counterparties have the same creditworthiness. To reflect the actual exposure on our derivative contracts related to both counterparty and our own creditworthiness, we record a fair value adjustment in the form of a credit valuation adjustment. The credit component is determined by individual counterparty based on the probability of default and considers master netting and collateral agreements. The credit valuation adjustment is classified as Level 3. Our MRM group is responsible for the valuation policies and procedures related to this credit valuation adjustment. A weekly reconciliation process is performed to ensure that all applicable derivative positions are covered in the calculation, which includes transmitting customer exposures and reserve reports to trading management, derivative traders and marketers, derivatives middle office, and corporate accounting personnel. On a quarterly basis, MRM prepares the credit valuation adjustment calculation, which includes a detailed reserve comparison with the previous quarter, an analysis for change in reserve, and a reserve forecast to ensure that the credit valuation adjustment recorded at period end is sufficient.

Other assets and liabilities. The value of our short positions is driven by the valuation of the underlying securities. If quoted prices for identical securities are not available, fair value is determined by using pricing models or quoted prices of similar securities, resulting in a Level 2 classification. For the interest rate-driven products, such as government bonds, U.S. Treasury bonds and other products backed by the U.S. government, inputs include spreads, credit ratings, and interest rates. For the credit-driven products, such as corporate bonds and mortgage-backed securities, inputs include actual trade data for comparable assets and bids and offers.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Certain assets and liabilities are measured at fair value on a recurring basis in accordance with GAAP. The following tables present these assets and liabilities at June 30, 2016, December 31, 2015, and June 30, 2015.


June 30, 2016 in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Trading account assets:
U.S. Treasury, agencies and corporations		—	$	708		—	$	708
States and political subdivisions		—		38		—		38
Collateralized mortgage obligations		—		—		—		—
Other mortgage-backed securities		—		162		—		162
Other securities		—		46		—		46

Total trading account securities		—		954		—		954
Commercial loans		—		11		—		11

Total trading account assets		—		965		—		965
Securities available for sale:
States and political subdivisions		—		11		—		11
Collateralized mortgage obligations		—		12,518		—		12,518
Other mortgage-backed securities		—		2,003		—		2,003
Other securities	$	3		—	$	17		20

Total securities available for sale		3		14,532		17		14,552
Other investments:
Principal investments:
Direct		16		—		24		40
Indirect (measured at NAV)^(a)		—		—		—		184

Total principal investments		16		—		24		224
Equity and mezzanine investments:
Indirect (measured at NAV)^(a)		—		—		—		8

Total equity and mezzanine investments		—		—		—		8

Total other investments		16		—		24		232
Derivative assets:
Interest rate		—		1,547		15		1,562
Foreign exchange		109		6		—		115
Commodity		—		213		—		213
Credit		—		2		2		4

Derivative assets		109		1,768		17		1,894
Netting adjustments ^(b)		—		—		—		(660	)

Total derivative assets		109		1,768		17		1,234
Accrued income and other assets		—		5		—		5

Total assets on a recurring basis at fair value	$	128	$	17,270	$	58	$	16,988

LIABILITIES MEASURED ON A RECURRING BASIS
Bank notes and other short-term borrowings:
Short positions	$	31	$	656		—	$	687
Derivative liabilities:
Interest rate		—		912		—		912
Foreign exchange		106		7		—		113
Commodity		—		201		—		201
Credit		—		4		—		4

Derivative liabilities		106		1,124		—		1,230
Netting adjustments ^(b)		—		—		—		(484	)

Total derivative liabilities		106		1,124		—		746
Accrued expense and other liabilities		—		5		—		5

Total liabilities on a recurring basis at fair value	$	137	$	1,785		—	$	1,438

(a)

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

(b)

Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with applicable accounting guidance. The net basis takes into account the impact of bilateral collateral and master netting agreements that allow us to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related cash collateral. Total derivative assets and liabilities include these netting adjustments.


December 31, 2015 in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Trading account assets:
U.S. Treasury, agencies and corporations		—	$	704		—	$	704
States and political subdivisions		—		25		—		25
Collateralized mortgage obligations		—		—		—		—
Other mortgage-backed securities		—		26		—		26
Other securities	$	3		24		—		27

Total trading account securities		3		779		—		782
Commercial loans		—		6		—		6

Total trading account assets		3		785		—		788
Securities available for sale:
States and political subdivisions		—		14		—		14
Collateralized mortgage obligations		—		11,995		—		11,995
Other mortgage-backed securities		—		2,189		—		2,189
Other securities		3		—	$	17		20

Total securities available for sale		3		14,198		17		14,218
Other investments:
Principal investments:
Direct		—		19		50		69
Indirect (measured at NAV)^(a)		—		—		—		235

Total principal investments		—		19		50		304
Equity and mezzanine investments:
Indirect (measured at NAV)^(a)		—		—		—		8

Total equity and mezzanine investments		—		—		—		8

Total other investments		—		19		50		312
Derivative assets:
Interest rate		—		868		16		884
Foreign exchange		143		8		—		151
Commodity		—		444		—		444
Credit		—		4		2		6

Derivative assets		143		1,324		18		1,485
Netting adjustments ^(b)		—		—		—		(866	)

Total derivative assets		143		1,324		18		619
Accrued income and other assets		—		1		—		1

Total assets on a recurring basis at fair value	$	149	$	16,327	$	85	$	15,938

LIABILITIES MEASURED ON A RECURRING BASIS
Bank notes and other short-term borrowings:
Short positions		—	$	533		—	$	533
Derivative liabilities:
Interest rate		—		563		—		563
Foreign exchange	$	116		8		—		124
Commodity		—		433		—		433
Credit		—		5	$	1		6

Derivative liabilities		116		1,009		1		1,126
Netting adjustments ^(b)		—		—		—		(494	)

Total derivative liabilities		116		1,009		1		632
Accrued expense and other liabilities		—		1		—		1

Total liabilities on a recurring basis at fair value	$	116	$	1,543	$	1	$	1,166

(a)

(b)


June 30, 2015 in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Trading account assets:
U.S. Treasury, agencies and corporations		—	$	580		—	$	580
States and political subdivisions		—		23		—		23
Collateralized mortgage obligations		—		—		—		—
Other mortgage-backed securities		—		37		—		37
Other securities	$	2		24		—		26

Total trading account securities		2		664		—		666
Commercial loans		—		8		—		8

Total trading account assets		2		672		—		674
Securities available for sale:
States and political subdivisions		—		19		—		19
Collateralized mortgage obligations		—		11,751		—		11,751
Other mortgage-backed securities		—		2,452		—		2,452
Other securities		12		—	$	10		22

Total securities available for sale		12		14,222		10		14,244
Other investments:
Principal investments:
Direct		—		—		70		70
Indirect (measured at NAV)^(a)		—		—		—		282

Total principal investments		—		—		70		352
Equity and mezzanine investments:
Indirect (measured at NAV)^(a)		—		—		—		9

Total equity and mezzanine investments		—		—		—		9
Other (measured at NAV)^(a)		—		—		—		4

Total other investments		—		—		70		365
Derivative assets:
Interest rate		—		840		16		856
Foreign exchange		121		10		—		131
Commodity		—		379		—		379
Credit		—		1		3		4

Derivative assets		121		1,230		19		1,370
Netting adjustments ^(b)		—		—		—		(834	)

Total derivative assets		121		1,230		19		536
Accrued income and other assets		—		2		—		2

Total assets on a recurring basis at fair value	$	135	$	16,126	$	99	$	15,821

LIABILITIES MEASURED ON A RECURRING BASIS
Bank notes and other short-term borrowings:
Short positions	$	1	$	527		—	$	528
Derivative liabilities:
Interest rate		—		568		—		568
Foreign exchange		100		8		—		108
Commodity		—		365		—		365
Credit		—		5		—		5

Derivative liabilities		100		946		—		1,046
Netting adjustments ^(b)		—		—		—		(486	)

Total derivative liabilities		100		946		—		560
Accrued expense and other liabilities		—		2		—		2

Total liabilities on a recurring basis at fair value	$	101	$	1,475		—	$	1,090

(a)

(b)

Changes in Level 3 Fair Value Measurements

The following table shows the components of the change in the fair values of our Level 3 financial instruments for the three and six months ended June 30, 2016, and June 30, 2015. We mitigate the credit risk, interest rate risk, and risk of loss related to many of these Level 3 instruments by using securities and derivative positions classified as Level 1 or Level 2. Level 1 and Level 2 instruments are not included in the following table. Therefore, the gains or losses shown do not include the impact of our risk management activities.


in millions	Beginning of Period Balance		Gains (Losses) Included in Earnings			Purchases		Sales			Settlements		Transfers into Level 3 ^(d)			Transfers out of Level 3 ^(d)			End of Period Balance ^(f)		Unrealized Gains (Losses) Included in Earnings
Six months ended June 30, 2016
Securities available for sale
Other securities	$	17		—			—		—			—		—			—		$	17		—
Other investments
Principal investments
Direct		50	$	3	^(b)		—	$	(29	)		—		—			—			24	$	(1	)^(b)
Other indirect		20		—			—		(20	)		—		—			—			—		(1	)^(b)
									—
Derivative instruments^(a)
Interest rate		16		6	^(c)		—		—			—	$	3	^(e)	$	(10	)^(e)		15		—
Credit		1		(6	)^(c)		—		—		$	7		—			—			2		—
Three months ended June 30, 2016
Securities available for sale
Other securities	$	17		—			—		—			—		—			—		$	17		—
Other investments
Principal investments
Direct		47	$	6	^(b)		—	$	(29	)		—		—			—			24	$	2	^(b)
Indirect		18		1	^(b)		—		(19	)		—		—			—			—		—
Derivative instruments^(a)
Interest rate		16		2	^(c)		—		—			—		—		$	(3	)^(e)		15		—
Credit		2		(4	)^(c)		—		—		$	4		—			—			2		—


in millions	Beginning of Period Balance		Gains (Losses) Included in Earnings			Purchases		Sales			Settlements		Transfers into Level 3 ^(d)			Transfers out of Level 3 ^(d)			End of Period Balance ^(f)		Unrealized Gains (Losses) Included in Earnings
Six months ended June 30, 2015
Securities available for sale
Other securities	$	10		—			—		—			—		—			—		$	10		—
Other investments
Principal investments
Direct		102	$	16	^(b)	$	2	$	(50	)		—		—			—			70	$	(3	)^(b)
Equity and mezzanine investments
Direct		—		2	^(b)		—		(2	)		—		—			—			—		2	^(b)
Derivative instruments^(a)
Interest rate		13		(1	)^(c)		1		—			—	$	8	^(e)	$	(5	)^(e)		16		—
Credit		2		(4	)^(c)		—		—		$	5		—			—			3		—
Three months ended June 30, 2015
Securities available for sale
Other securities	$	10		—			—		—			—		—			—		$	10		—
Other investments
Principal investments
Direct		73	$	3	^(b)	$	1	$	(7	)		—		—			—			70	$	(3	)^(b)
Derivative instruments^(a)
Interest rate		10		(3	)^(c)		1		—			—	$	8	^(e)		—			16		—
Credit		2		(1	)^(c)		—		—		$	2		—			—			3		—

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

(b)	Realized and unrealized gains and losses on principal investments are reported in “net gains (losses) from principal investing” on the income statement. Realized and unrealized losses on private equity and mezzanine investments are reported in “other income” on the income statement.

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

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

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

(f)	There were no issuances for the six-month periods ended June 30, 2016, and June 30, 2015.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities are measured at fair value on a nonrecurring basis in accordance with GAAP. The adjustments to fair value generally result from the application of accounting guidance that requires assets and liabilities to be recorded at the lower of cost or fair value, or assessed for impairment. There were no liabilities measured at fair value on a nonrecurring basis at June 30, 2016, December 31, 2015, and June 30, 2015. The following table presents our assets measured at fair value on a nonrecurring basis at June 30, 2016, December 31, 2015, and June 30, 2015:


	June 30, 2016
in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A NONRECURRING BASIS
Impaired loans		—		—	$	8	$	8
Loans held for sale ^(a)		—		—		—		—
Accrued income and other assets		—		—		4		4

Total assets on a nonrecurring basis at fair value		—		—	$	12	$	12


	December 31, 2015
in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A NONRECURRING BASIS
Impaired loans		—		—		—		—
Loans held for sale ^(a)		—		—		—		—
Accrued income and other assets		—		—	$	7	$	7

Total assets on a nonrecurring basis at fair value		—		—	$	7	$	7


	June 30, 2015
in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A NONRECURRING BASIS
Impaired loans		—		—	$	8	$	8
Loans held for sale ^(a)		—		—		—		—
Accrued income and other assets		—		—		5		5

Total assets on a nonrecurring basis at fair value		—		—	$	13	$	13

(a)	During the first half of 2016, we transferred $22 million of commercial and consumer loans and leases at their current fair value from held-to-maturity portfolio to held-for-sale status, compared to $62 million during 2015, and $7 million during the first half of 2015.

Impaired loans. We typically adjust the carrying amount of our impaired loans when there is evidence of probable loss and the expected fair value of the loan is less than its contractual amount. The amount of the impairment may be determined based on the estimated present value of future cash flows, the fair value of the underlying collateral, or the loan’s observable market price. Impaired loans with a specifically allocated allowance based on cash flow analysis or the value of the underlying collateral are classified as Level 3 assets. Impaired loans with a specifically allocated allowance based on an observable market price that reflects recent sale transactions for similar loans and collateral are classified as Level 2 assets.

The evaluations for impairment are prepared by the responsible relationship managers in our Asset Recovery Group and are reviewed and approved by the Asset Recovery Group Executive. The Asset Recovery Group is part of the Risk Management Group and reports to our Chief Credit Officer. These evaluations are performed in conjunction with the quarterly ALLL process.

Loans are evaluated for impairment on a quarterly basis. Loans included in the previous quarter’s review are re-evaluated, and if their values have changed materially, the underlying information (loan balance and in most cases, collateral value) is compared. Material differences are evaluated for reasonableness, and the relationship managers and their senior managers consider these differences and determine if any adjustment is necessary. The inputs are developed and substantiated on a quarterly basis based on current borrower developments, market conditions, and collateral values.

The following two internal methods are used to value impaired loans:

•

Cash flow analysis considers internally developed inputs, such as discount rates, default rates, costs of foreclosure, and changes in collateral values.

•

The fair value of the collateral, which may take the form of real estate or personal property, is based on internal estimates, field observations, and assessments provided by third-party appraisers. We perform or reaffirm appraisals of collateral-dependent impaired loans at least annually. Appraisals may occur more frequently if the most recent appraisal does not accurately reflect the current market, the debtor is seriously delinquent or chronically past due, or there has been a material deterioration in the performance of the project or condition of the property. Adjustments to outdated appraisals that result in an appraisal value less than the carrying amount of a collateral-dependent impaired loan are reflected in the ALLL.

Impairment valuations are back-tested each quarter, based on a look-back of actual incurred losses on closed deals previously evaluated for impairment. The overall percent variance of actual net loan charge-offs on closed deals compared to the specific allocations on such deals is considered in determining each quarter’s specific allocations.

Loans held for sale. Through a quarterly analysis of our loan portfolios held for sale, which include both performing and nonperforming loans, we determine any adjustments necessary to record the portfolios at the lower of cost or fair value in accordance with GAAP. Our analysis concluded that there were no loans held for sale adjusted to fair value at June 30, 2016, December 31, 2015, or June 30, 2015.

Market inputs, including updated collateral values, and reviews of each borrower’s financial condition influenced the inputs used in our internal models and other valuation methodologies. The valuations are prepared by the responsible relationship managers or analysts in our Asset Recovery Group and are reviewed and approved by the Asset Recovery Group Executive. Actual gains or losses realized on the sale of various loans held for sale provide a back-testing mechanism for determining whether our valuations of these loans held for sale that are adjusted to fair value are appropriate.

Valuations of performing commercial mortgage and construction loans held for sale are conducted using internal models that rely on market data from sales or nonbinding bids on similar assets, including credit spreads, treasury rates, interest rate curves, and risk profiles. These internal models also rely on our own assumptions about the exit market for the loans and details about individual loans within the respective portfolios. Therefore, we classify these loans as Level 3 assets. The inputs related to our assumptions and other internal loan data include changes in real estate values, costs of foreclosure, prepayment rates, default rates, and discount rates.

Valuations of nonperforming commercial mortgage and construction loans held for sale are based on current agreements to sell the loans or approved discounted payoffs. If a negotiated value is not available, we use third-party appraisals, adjusted for current market conditions. Since valuations are based on unobservable data, these loans are classified as Level 3 assets.

Direct financing leases and operating lease assets held for sale. Our KEF Accounting and Capital Markets groups are responsible for the valuation policies and procedures related to these assets. The Managing Director of the KEF Capital Markets group reports to the President of the KEF line of business. A weekly report is distributed to both groups that lists all equipment finance deals booked in the warehouse portfolio. On a quarterly basis, the KEF Accounting group prepares a detailed held-for-sale roll-forward schedule that is reconciled to the general ledger and the above mentioned weekly report. KEF management uses the held-for-sale roll-forward schedule to determine if an impairment adjustment is necessary in accordance with lower of cost or fair value guidelines.

Valuations of direct financing leases and operating lease assets held for sale are performed using an internal model that relies on market data, such as swap rates and bond ratings, as well as our own assumptions about the exit market for the leases and details about the individual leases in the portfolio. The inputs based on our assumptions include changes in the value of leased items and internal credit ratings. These leases have been classified as Level 3 assets. KEF has master sale and assignment agreements with numerous institutional investors. Historically, multiple quotes are obtained, with the most reasonable formal quotes retained. These nonbinding quotes generally lead to a sale to one of the parties who provided the quote. Leases for which we receive a current nonbinding bid, and for which the sale is considered probable, may be classified as Level 2. The validity of these quotes is supported by historical and continued dealings with these institutions that have fulfilled the nonbinding quote in the past. In a distressed market where market data is not available, an estimate of the fair value of the leased asset may be used to value the lease, resulting in a Level 3 classification. In an inactive market, the market value of the assets held for sale is determined as the present value of the future cash flows discounted at the current

buy rate. KEF Accounting calculates an estimated fair value buy rate based on the credit premium inherent in the relevant bond index and the appropriate swap rate on the measurement date. The amount of the adjustment is calculated as book value minus the present value of future cash flows discounted at the calculated buy rate.

Goodwill and other intangible assets. On a quarterly basis, we review impairment indicators to determine whether we need to evaluate the carrying amount of goodwill and other intangible assets assigned to Key Community Bank and Key Corporate Bank. We also perform an annual impairment test for goodwill. Accounting guidance permits an entity to first assess qualitative factors to determine whether additional goodwill impairment testing is required. However, we did not choose to utilize a qualitative assessment in our annual goodwill impairment testing performed during the fourth quarter of 2015. Fair value of our reporting units is determined using both an income approach (discounted cash flow method) and a market approach (using publicly traded company and recent transactions data), which are weighted equally.

Inputs used include market-available data, such as industry, historical, and expected growth rates, and peer valuations, as well as internally driven inputs, such as forecasted earnings and market participant insights. Since this valuation relies on a significant number of unobservable inputs, we have classified goodwill as Level 3. We use a third-party valuation services provider to perform the annual, and if necessary, any interim, Step 1 valuation process, and to perform a Step 2 analysis, if needed, on our reporting units. Annual and any interim valuations prepared by the third-party valuation services provider are reviewed by the appropriate individuals within Key to ensure that the assumptions used in preparing the analysis are appropriate and properly supported. For additional information on the results of recent goodwill impairment testing, see Note 10 (“Goodwill and Other Intangible Assets”) beginning on page 181 of our 2015 Form 10-K.

The fair value of other intangible assets is calculated using a cash flow approach. While the calculation to test for recoverability uses a number of assumptions that are based on current market conditions, the calculation is based primarily on unobservable assumptions. Accordingly, these assets are classified as Level 3. Our lines of business, with oversight from our Accounting group, are responsible for routinely, at least quarterly, assessing whether impairment indicators are present. All indicators that signal impairment may exist are appropriately considered in this analysis. An impairment loss is only recognized for a held-and-used long-lived asset if the sum of its estimated future undiscounted cash flows used to test for recoverability is less than its carrying value.

Our primary assumptions include attrition rates, alternative costs of funds, and rates paid on deposits. For additional information on the results of other intangible assets impairment testing, see Note 10 (“Goodwill and Other Intangible Assets”) beginning on page 181 of our 2015 Form 10-K.

Other assets. OREO and other repossessed properties are valued based on inputs such as appraisals and third-party price opinions, less estimated selling costs. Generally, we classify these assets as Level 3, but OREO and other repossessed properties for which we receive binding purchase agreements are classified as Level 2. Returned lease inventory is valued based on market data for similar assets and is classified as Level 2. Assets that are acquired through, or in lieu of, loan foreclosures are recorded initially as held for sale at fair value less estimated selling costs at the date of foreclosure. After foreclosure, valuations are updated periodically, and current market conditions may require the assets to be marked down further to a new cost basis.

•

Commercial Real Estate Valuation Process: When a loan is reclassified from loan status to OREO because we took possession of the collateral, the Asset Recovery Group Loan Officer, in consultation with our OREO group, obtains a broker price opinion or a third-party appraisal, which is used to establish the fair value of the underlying collateral. The determined fair value of the underlying collateral less estimated selling costs becomes the carrying value of the OREO asset. In addition to valuations from independent third-party sources, our OREO group also writes down the carrying balance of OREO assets once a bona fide offer is contractually accepted, where the accepted price is lower than the current balance of the particular OREO asset. The fair value of OREO property is re-evaluated every 90 days, and the OREO asset is adjusted as necessary.

•

Consumer Real Estate Valuation Process: The Asset Management team within our Risk Operations group is responsible for valuation policies and procedures in this area. The current vendor partner provides monthly reporting of all broker price opinion evaluations, appraisals, and the monthly market plans. Market plans are reviewed monthly, and valuations are reviewed and tested monthly to ensure proper pricing has been established and guidelines are being met. Risk Operations Compliance validates and provides periodic testing of the valuation process. The Asset Management team reviews changes in fair value measurements. Third-party broker price opinions are reviewed every 180 days, and the fair value is written down based on changes to the valuation. External factors are documented and monitored as appropriate.

Quantitative Information about Level 3 Fair Value Measurements

The range and weighted-average of the significant unobservable inputs used to fair value our material Level 3 recurring and nonrecurring assets at June 30, 2016, December 31, 2015, and June 30, 2015, along with the valuation techniques used, are shown in the following table:

June 30, 2016

dollars in millions

Fair Value of
Level 3 Assets

Valuation Technique

Significant

Unobservable Input

Range
(Weighted-Average)

Recurring

Other investments — principal investments — direct:

Individual analysis of the condition of each investment

Debt instruments

EBITDA multiple

5.30 - 6.30 (6.20

)

Equity instruments of private companies

EBITDA multiple (where applicable)

6.30

Nonrecurring

Impaired loans

Fair value of underlying collateral

Discount

00.00 - 35.00% (6.00

Goodwill

1,060

Discounted cash flow and market data

Earnings multiple of peers

10.30 - 17.80 (12.79

)

Equity multiple of peers

1.25 - 1.56 (1.43

)

Control premium

10.00 - 30.00% (19.18%

)

Weighted-average cost of capital

12.00 - 13.00% (12.54%

)

December 31, 2015

dollars in millions

Fair Value of
Level 3 Assets

Valuation Technique

Significant

Unobservable Input

Range
(Weighted-Average)

Recurring

Other investments — principal investments — direct:

Individual analysis of the condition of each investment

Debt instruments

EBITDA multiple

N/A (5.40

)

Equity instruments of private companies

EBITDA multiple (where applicable)

5.40 - 6.70 (6.60

)

Nonrecurring

Impaired loans^(a)

—

Fair value of underlying collateral

Discount

00.00 - 34.00% (15.00

Goodwill

1,060

Discounted cash flow and market data

Earnings multiple of peers

10.30 - 17.80 (12.79

)

Equity multiple of peers

1.25 - 1.56 (1.43

)

Control premium

10.00 - 30.00% (19.18%

)

Weighted-average cost of capital

12.00 - 13.00% (12.54%

)

(a) Impaired loans are less than $1 million at December 31, 2015.

June 30, 2015

dollars in millions

Fair Value of
Level 3 Assets

Valuation Technique

Significant

Unobservable Input

Range
(Weighted-Average)

Recurring

Other investments — principal investments — direct:

Individual analysis of the condition of each investment

Debt instruments

EBITDA multiple

5.40 - 6.00 (5.50)

Equity instruments of private companies

EBITDA multiple (where applicable)

6.00 - 6.80 (6.70)

Equity instruments of public companies

Market approach

Discount

N/A (8.00)

Nonrecurring

Impaired loans

Fair value of underlying collateral

Discount

00.00 - 64.00% (35.00%)

Goodwill

1,057

Discounted cash flow and market data

Earnings multiple of peers

11.40 - 15.90 (12.92)

Equity multiple of peers

1.20 - 1.22 (1.21)

Control premium

10.00 - 30.00% (19.70%)

Weighted-average cost of capital

13.00 - 14.00% (13.52%)

Fair Value Disclosures of Financial Instruments

The levels in the fair value hierarchy ascribed to our financial instruments and the related carrying amounts at June 30, 2016, December 31, 2015, and June 30, 2015, are shown in the following table.


	June 30, 2016
			Fair Value
in millions	Carrying Amount		Level 1		Level 2		Level 3		Measured at NAV		Netting Adjustment			Total
ASSETS
Cash and short-term investments ^(a)	$	7,095	$	7,095		—		—		—		—		$	7,095
Trading account assets ^(b)		965		—	$	965		—		—		—			965
Securities available for sale ^(b)		14,552		3		14,532	$	17		—		—			14,552
Held-to-maturity securities ^(c)		4,832		—		4,889		—		—		—			4,889
Other investments ^(b)		577		16		—		369	$	192		—			577
Loans, net of allowance ^(d)		61,244		—		—		60,166		—		—			60,166
Loans held for sale^(b)		442		—		—		442		—		—			442
Derivative assets^(b)		1,234		109		1,768		17		—	$	(660	)^(f)		1,234

LIABILITIES
Deposits with no stated maturity ^(a)	$	68,677		—	$	68,677		—		—		—		$	68,677
Time deposits ^(e)		6,648		—		6,721		—		—		—			6,721
Short-term borrowings ^(a)		1,047	$	31		1,016		—		—		—			1,047
Long-term debt^(e)		11,388		11,492		376		—		—		—			11,868
Derivative liabilities^(b)		746		106		1,124		—		—	$	(484	)^(f)		746

	December 31, 2015
			Fair Value
in millions	Carrying Amount		Level 1		Level 2		Level 3		Measured at NAV		Netting Adjustment			Total
ASSETS
Cash and short-term investments ^(a)	$	3,314	$	3,314		—		—		—		—		$	3,314
Trading account assets ^(b)		788		3	$	785		—		—		—			788
Securities available for sale ^(b)		14,218		3		14,198	$	17		—		—			14,218
Held-to-maturity securities ^(c)		4,897		—		4,848		—		—		—			4,848
Other investments ^(b)		655		—		19		393	$	243		—			655
Loans, net of allowance ^(d)		59,080		—		—		57,508		—		—			57,508
Loans held for sale^(b)		639		—		—		639		—		—			639
Derivative assets^(b)		619		143		1,324		18		—	$	(866	)^(f)		619

LIABILITIES
Deposits with no stated maturity ^(a)	$	65,527		—	$	65,527		—		—		—		$	65,527
Time deposits ^(e)		5,519		—		5,575		—		—		—			5,575
Short-term borrowings ^(a)		905		—		905		—		—		—			905
Long-term debt^(e)		10,186	$	9,987		420		—		—		—			10,407
Derivative liabilities^(b)		632		116		1,009	$	1		—	$	(494	)^(f)		632

	June 30, 2015
			Fair Value
in millions	Carrying Amount		Level 1		Level 2		Level 3		Measured at NAV		Netting Adjustment			Total
ASSETS
Cash and short-term investments ^(a)	$	3,915	$	3,915		—		—		—		—		$	3,915
Trading account assets ^(b)		674		2	$	672		—		—		—			674
Securities available for sale ^(b)		14,244		12		14,222	$	10		—		—			14,244
Held-to-maturity securities ^(c)		5,022		—		4,992		—		—		—			4,992
Other investments ^(b)		703		—		—		408		295		—			703
Loans, net of allowance ^(d)		57,468		—		—		56,012		—		—			56,012
Loans held for sale ^(b)		835		—		—		835		—		—			835
Derivative assets^(b)		536		121		1,230		19		—	$	(834	)^(f)		536

LIABILITIES
Deposits with no stated maturity ^(a)	$	65,034		—	$	65,034		—		—		—		$	65,034
Time deposits ^(e)		5,635	$	498		5,195		—		—		—			5,693
Short-term borrowings ^(a)		972		1		971		—		—		—			972
Long-term debt^(e)		10,267		10,037		506		—		—		—			10,543
Derivative liabilities^(b)		560		100		946		—		—	$	(486	)^(f)		560

Valuation Methods and Assumptions

(a)	Fair value equals or approximates carrying amount. The fair value of deposits with no stated maturity does not take into consideration the value ascribed to core deposit intangibles.

(b)	Information pertaining to our methodology for measuring the fair values of these assets and liabilities is included in the sections entitled “Qualitative Disclosures of Valuation Techniques” and “Assets Measured at Fair Value on a Nonrecurring Basis” in this Note.

(c)

Fair values of held-to-maturity securities are determined by using models that are based on security-specific details, as well as relevant industry and economic factors. The most significant of these inputs are quoted market prices, interest rate spreads on relevant benchmark securities, and certain prepayment assumptions. We review the valuations derived from the models to ensure they are reasonable and consistent with the values placed on similar securities traded in the secondary markets.

(d)

The fair value of loans is based on the present value of the expected cash flows. The projected cash flows are based on the contractual terms of the loans, adjusted for prepayments and use of a discount rate based on the relative risk of the cash flows, taking into account the loan type, maturity of the loan, liquidity risk, servicing costs, and a required return on debt and capital. In addition, an incremental liquidity discount is applied to certain loans, using historical sales of loans during periods of similar economic conditions as a benchmark. The fair value of loans includes lease financing receivables at their aggregate carrying amount, which is equivalent to their fair value.

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

(f)

We use valuation methods based on exit market prices in accordance with applicable accounting guidance. We determine fair value based on assumptions pertaining to the factors that a market participant would consider in valuing the asset. A substantial portion of our fair value adjustments are related to liquidity. During 2015 and the first half of 2016, the fair values of our loan portfolios generally remained stable, primarily due to increasing liquidity in the loan markets. If we were to use different assumptions, the fair values shown in the preceding table could change. Also, because the applicable accounting guidance for financial instruments excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements, the fair value amounts shown in the table above do not, by themselves, represent the underlying value of our company as a whole.

Education lending business. The discontinued education lending business consists of loans in portfolio (recorded at carrying value with appropriate valuation reserves) and loans in portfolio (recorded at fair value). All of these loans were excluded from the table above as follows:

•

Loans at carrying value, net of allowance, of $1.7 billion ($1.4 billion at fair value) at June 30, 2016, and $1.8 billion ($1.5 billion at fair value) at December 31, 2015, and $1.9 billion ($1.6 billion at fair value) at June 30, 2015; and

•

Portfolio loans at fair value of $3 million at June 30, 2016, and $4 million at December 31, 2015. There were no portfolio loans at fair value at June 30, 2015.

These loans and securities are classified as Level 3 because we rely on unobservable inputs when determining fair value since observable market data is not available.

Residential real estate mortgage loans. Residential real estate mortgage loans with carrying amounts of $2.3 billion at June 30, 2016, $2.2 billion at December 31, 2015, and $2.3 billion at June 30, 2015 are included in “Loans, net of allowance” in the previous table.

Short-term financial instruments. For financial instruments with a remaining average life to maturity of less than six months, carrying amounts were used as an approximation of fair values.

6. Securities

Securities available for sale. These are securities that we intend to hold for an indefinite period of time but that may be sold in response to changes in interest rates, prepayment risk, liquidity needs, or other factors. Securities available for sale are reported at fair value. Unrealized gains and losses (net of income taxes) deemed temporary are recorded in equity as a component of AOCI on the balance sheet. Unrealized losses on equity securities deemed to be “other-than-temporary,” and realized gains and losses resulting from sales of securities using the specific identification method, are included in “other income” on the income statement. Unrealized losses on debt securities deemed to be “other-than-temporary” are included in “other income” on the income statement or in AOCI on the balance sheet in accordance with the applicable accounting guidance related to the recognition of OTTI of debt securities.

“Other securities” held in the available-for-sale portfolio consist of marketable equity securities that are traded on a public exchange such as the NYSE or NASDAQ and convertible preferred stock issued by privately held companies.

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

“Other securities” held in the held-to-maturity portfolio consist of foreign bonds and capital securities.

Unrealized losses on equity securities deemed to be “other-than-temporary,” and realized gains and losses resulting from sales of securities using the specific identification method, are included in “other income” on the income statement. Unrealized losses on debt securities deemed to be “other-than-temporary” are included in “other income” on the income statement or in AOCI on the balance sheet in accordance with the applicable accounting guidance related to the recognition of OTTI of debt securities.

The amortized cost, unrealized gains and losses, and approximate fair value of our securities available for sale and held-to-maturity securities are presented in the following tables. Gross unrealized gains and losses represent 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 change.


	June 30, 2016
in millions	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
SECURITIES AVAILABLE FOR SALE
States and political subdivisions	$	11	$	1		—	$	12
Collateralized mortgage obligations		12,344		187	$	13		12,518
Other mortgage-backed securities		1,970		32		—		2,002
Other securities		21		—		1		20

Total securities available for sale	$	14,346	$	220	$	14	$	14,552

HELD-TO-MATURITY SECURITIES
Collateralized mortgage obligations	$	4,099	$	45	$	6	$	4,138
Other mortgage-backed securities		711		18		—		729
Other securities		22		—		—		22

Total held-to-maturity securities	$	4,832	$	63	$	6	$	4,889


	December 31, 2015
in millions	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
SECURITIES AVAILABLE FOR SALE
States and political subdivisions	$	14		—		—	$	14
Collateralized mortgage obligations		12,082	$	51	$	138		11,995
Other mortgage-backed securities		2,193		11		15		2,189
Other securities		21		—		1		20

Total securities available for sale	$	14,310	$	62	$	154	$	14,218

HELD-TO-MATURITY SECURITIES
Collateralized mortgage obligations	$	4,174	$	5	$	50	$	4,129
Other mortgage-backed securities		703		—		4		699
Other securities		20		—		—		20

Total held-to-maturity securities	$	4,897	$	5	$	54	$	4,848


	June 30, 2015
in millions	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
SECURITIES AVAILABLE FOR SALE
States and political subdivisions	$	19		—		—	$	19
Collateralized mortgage obligations		11,765	$	101	$	115		11,751
Other mortgage-backed securities		2,439		21		8		2,452
Other securities		20		2		—		22

Total securities available for sale	$	14,243	$	124	$	123	$	14,244

HELD-TO-MATURITY SECURITIES
Collateralized mortgage obligations	$	4,463	$	17	$	43	$	4,437
Other mortgage-backed securities		539		—		4		535
Other securities		20		—		—		20

Total held-to-maturity securities	$	5,022	$	17	$	47	$	4,992

The following table summarizes our securities that were in an unrealized loss position as of June 30, 2016, December 31, 2015, and June 30, 2015.


	Duration of Unrealized Loss Position
	Less than 12 Months				12 Months or Longer				Total
in millions	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
June 30, 2016
Securities available for sale:
Collateralized mortgage obligations	$	410	$	1	$	1,626	$	12	$	2,036	$	13
Other securities		—		—		3		1		3		1
Held-to-maturity:
Collateralized mortgage obligations		128		1		582		5		710		6
Other securities^(a)		—		—		4		—		4		—

Total temporarily impaired securities	$	538	$	2	$	2,215	$	18	$	2,753	$	20

December 31, 2015
Securities available for sale:
Collateralized mortgage obligations	$	5,190	$	43	$	3,206	$	95	$	8,396	$	138
Other mortgage-backed securities		1,670		15		—		—		1,670		15
Other securities		—		—		3		1		3		1
Held-to-maturity:
Collateralized mortgage obligations		1,793		16		1,320		34		3,113		50
Other mortgage-backed securities		547		4		—		—		547		4
Other securities^(a)		4		—		—		—		4		—

Total temporarily impaired securities	$	9,204	$	78	$	4,529	$	130	$	13,733	$	208

June 30, 2015
Securities available for sale:
Collateralized mortgage obligations	$	2,784	$	46	$	2,624	$	69	$	5,408	$	115
Other mortgage-backed securities		1,060		8		—		—		1,060		8
Other securities^(b)		—		—		3		—		3		—
Held-to-maturity:
Collateralized mortgage obligations		1,236		12		1,278		31		2,514		43
Other mortgage-backed securities		475		4		—		—		475		4
Other securities^(a)		4		—		—		—		4		—

Total temporarily impaired securities	$	5,559	$	70	$	3,905	$	100	$	9,464	$	170

(a)	Gross unrealized losses totaled less than $1 million for other securities held to maturity as of June 30, 2016, December 31, 2015, and June 30, 2015.

(b)	Gross unrealized losses totaled less than $1 million for other securities available for sale as of June 30, 2015.

At June 30, 2016, we had $13 million of gross unrealized losses related to 33 fixed-rate CMOs that we invested in as part of our overall A/LM strategy. These securities had a weighted-average maturity of 3.8 years at June 30, 2016. We also had less than $1 million of gross unrealized losses related to 7 other mortgage-backed securities positions, which had a weighted-average maturity of 3.9 years at June 30, 2016. Because these securities have a fixed interest rate, their fair value is sensitive to movements in market interest rates. These unrealized losses are considered temporary since we expect to collect all contractually due amounts from these securities. Accordingly, these investments were reduced to their fair value through OCI, not earnings.

We regularly assess our securities portfolio for OTTI. The assessments are based on the nature of the securities, the underlying collateral, the financial condition of the issuer, the extent and duration of the loss, our intent related to the individual securities, and the likelihood that we will have to sell securities prior to expected recovery.

The debt securities identified as other-than-temporarily impaired are written down to their current fair value. For those debt securities that we intend to sell, or more-likely-than-not will be required to sell, prior to the expected recovery of the amortized cost, the entire impairment (i.e., the difference between amortized cost and the fair value) is recognized in earnings. For those debt securities that we do not intend to sell, or more-likely-than-not will not be required to sell, prior to expected recovery, the credit portion of OTTI is recognized in earnings, while the remaining OTTI is recognized in equity as a component of AOCI on the balance sheet. As shown in the following table, we did not have any impairment losses recognized in earnings for the three months ended June 30, 2016.


Three months ended June 30, 2016 in millions
Balance at March 31, 2016	$	4
Impairment recognized in earnings		—

Balance at June 30, 2016	$	4

For the six months ended June 30, 2016, net securities gains (losses) related to securities available for sale totaled less than $1 million.

At June 30, 2016, securities available for sale and held-to-maturity securities totaling $5.7 billion were pledged to secure securities sold under repurchase agreements, to secure public and trust deposits, to facilitate access to secured funding, and for other purposes required or permitted by law.

The following table shows securities by remaining maturity. CMOs and other mortgage-backed securities (both of which are included in the securities available-for-sale portfolio) as well as the CMOs in the held-to-maturity portfolio are presented based on their expected average lives. The remaining securities, in both the available-for-sale and held-to-maturity portfolios, are presented based on their remaining contractual maturity. Actual maturities may differ from expected or contractual maturities since borrowers have the right to prepay obligations with or without prepayment penalties.


	Securities Available for Sale				Held-to-Maturity Securities
June 30, 2016 in millions	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	249	$	252	$	86	$	87
Due after one through five years		13,456		13,649		4,035		4,073
Due after five through ten years		640		649		711		729
Due after ten years		1		2		—		—

Total	$	14,346	$	14,552	$	4,832	$	4,889

7. Derivatives and Hedging Activities

We are a party to various derivative instruments, mainly through our subsidiary, KeyBank. Derivative instruments are contracts between two or more parties that have a notional amount and an underlying variable, require a small or no net investment, and allow for the net settlement of positions. A derivative’s notional amount serves as the basis for the payment provision of the contract and takes the form of units, such as shares or dollars. A derivative’s underlying variable is a specified interest rate, security price, commodity price, foreign exchange rate, index, or other variable. The interaction between the notional amount and the underlying variable determines the number of units to be exchanged between the parties and influences the fair value of the derivative contract.

The primary derivatives that we use are interest rate swaps, caps, floors, and futures; foreign exchange contracts; commodity derivatives; and credit derivatives. Generally, these instruments help us manage exposure to interest rate risk, mitigate the credit risk inherent in our loan portfolio, hedge against changes in foreign currency exchange rates, and meet client financing and hedging needs. As further discussed in this note:

•

interest rate risk is the risk that the EVE or net interest income will be adversely affected by fluctuations in interest rates;

•

credit risk is the risk of loss arising from an obligor’s inability or failure to meet contractual payment or performance terms; and

•

foreign exchange risk is the risk that an exchange rate will adversely affect the fair value of a financial instrument.

Derivative assets and liabilities are recorded at fair value on the balance sheet, after taking into account the effects of bilateral collateral and master netting agreements. These agreements allow us to settle all derivative contracts held with a single counterparty on a net basis and to offset net derivative positions with related cash collateral, where applicable. As a result, we 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 June 30, 2016, after taking into account the effects of bilateral collateral and master netting agreements, we had $398 million of derivative assets and a positive $6 million of derivative liabilities that relate to contracts entered into for hedging purposes. Our hedging derivative liabilities are in an asset position largely because we have contracts with positive fair values as a result of master netting agreements. As of the same date, after taking into account the effects of bilateral collateral and master netting agreements and a reserve for potential future losses, we had derivative assets of $836 million and derivative liabilities of $752 million that were not designated as hedging instruments.

Additional information regarding our accounting policies for derivatives is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Derivatives” beginning on page 126 of our 2015 Form 10-K.

Derivatives Designated in Hedge Relationships

Net interest income and the EVE change in response to changes in the mix of assets, liabilities, and off-balance sheet instruments; associated interest rates tied to each instrument; differences in the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities; and changes in interest rates. We utilize derivatives that have been designated as part of a hedge relationship in accordance with the applicable accounting guidance to minimize the exposure and volatility of net interest income and EVE to interest rate fluctuations. The primary derivative instruments used to manage interest rate risk are interest rate swaps, which convert the contractual interest rate index of agreed-upon amounts of assets and liabilities (i.e., notional amounts) to another interest rate index.

We designate certain “receive fixed/pay variable” interest rate swaps as fair value hedges. These contracts convert certain fixed-rate long-term debt into variable-rate obligations, thereby modifying our exposure to changes in interest rates. As a result, we receive fixed-rate interest payments in exchange for making variable-rate payments over the lives of the contracts without exchanging the notional amounts.

Similarly, we designate certain “receive fixed/pay variable” interest rate swaps as cash flow hedges. These contracts effectively convert certain floating-rate loans into fixed-rate loans to reduce the potential adverse effect of interest rate decreases on future interest income. Again, we receive fixed-rate interest payments in exchange for making variable-rate payments over the lives of the contracts without exchanging the notional amounts.

We also designate certain “pay fixed/receive variable” interest rate swaps as cash flow hedges. These swaps convert certain floating-rate debt into fixed-rate debt. We also use these swaps to manage the interest rate risk associated with anticipated sales of certain commercial real estate loans. The swaps protect against the possible short-term decline in the value of the loans that could result from changes in interest rates between the time they are originated and the time they are sold.

We use foreign currency forward transactions to hedge the foreign currency exposure of our net investment in various foreign equipment finance entities. These entities are denominated in a non-U.S. currency. These swaps are designated as net investment hedges to mitigate the exposure of measuring the net investment at the spot foreign exchange rate.

Derivatives Not Designated in Hedge Relationships

On occasion, we enter into interest rate swap contracts to manage economic risks but do not designate the instruments in hedge relationships. Excluding contracts addressing customer exposures, the amount of derivatives hedging risks on an economic basis at June 30, 2016, was not significant.

Like other financial services institutions, we originate loans and extend credit, both of which expose us to credit risk. We actively manage our overall loan portfolio and the associated credit risk in a manner consistent with asset quality objectives and concentration risk tolerances to mitigate portfolio credit risk. Purchasing credit default swaps enables us to transfer to a third party a portion of the credit risk associated with a particular extension of credit, including situations where there is a forecasted sale of loans. Beginning in the first quarter of 2014, we began purchasing credit default swaps to reduce the credit risk associated with the debt securities held in our trading portfolio. We may also sell credit derivatives to offset our purchased credit default swap position prior to maturity. Although we use credit default swaps for risk management purposes, they are not treated as hedging instruments.

We also enter into derivative contracts for other purposes, including:

•

interest rate swap, cap, and floor contracts entered into generally to accommodate the needs of commercial loan clients;

•

energy and base metal swap and option contracts entered into to accommodate the needs of clients;

•

futures contracts and positions with third parties that are intended to offset or mitigate the interest rate or market risk related to client positions discussed above; and

•

foreign exchange forward and option contracts entered into primarily to accommodate the needs of clients.

These contracts are not designated as part of hedge relationships.

Fair Values, Volume of Activity, and Gain/Loss Information Related to Derivative Instruments

The following table summarizes the fair values of our derivative instruments on a gross and net basis as of June 30, 2016, December 31, 2015, and June 30, 2015. The change in the notional amounts of these derivatives by type from December 31, 2015, to June 30, 2016, indicates the volume of our derivative transaction activity during the first half of 2016. The notional amounts are not affected by bilateral collateral and master netting agreements. The derivative asset and liability balances are presented on a gross basis, prior to the application of bilateral collateral and master netting agreements. Total derivative assets and liabilities are adjusted to take into account the impact of legally enforceable master netting agreements that allow us to settle all derivative contracts with a single counterparty on a net basis and to offset the net derivative position with the related cash collateral. Where master netting agreements are not in effect or are not enforceable under bankruptcy laws, we do not adjust those derivative assets and liabilities with counterparties. Securities collateral related to legally enforceable master netting agreements is not offset on the balance sheet. Our derivative instruments are included in “derivative assets” or “derivative liabilities” on the balance sheet, as indicated in the following table:


	June 30, 2016								December 31, 2015								June 30, 2015
			Fair Value								Fair Value								Fair Value
in millions	Notional Amount		Derivative Assets			Derivative Liabilities			Notional Amount		Derivative Assets			Derivative Liabilities			Notional Amount		Derivative Assets			Derivative Liabilities
Derivatives designated as hedging instruments:
Interest rate	$	22,754	$	572		$	13		$	18,917	$	257		$	15		$	17,324	$	267		$	22
Foreign exchange		289		8			13			312		20			—			333		17			4

Total		23,043		580			26			19,229		277			15			17,657		284			26
Derivatives not designated as hedging instruments:
Interest rate		44,498		990			899			43,965		627			548			45,067		589			546
Foreign exchange		6,148		107			100			6,454		131			124			6,486		114			104
Commodity		1,319		213			201			1,144		444			433			1,537		379			365
Credit		467		4			4			632		6			6			505		4			5

Total		52,432		1,314			1,204			52,195		1,208			1,111			53,595		1,086			1,020
Netting adjustments ^(a)		—		(660	)		(484	)		—		(866	)		(494	)		—		(834	)		(486	)

Net derivatives in the balance sheet		75,475		1,234			746			71,424		619			632			71,252		536			560
Other collateral^(b)		—		(48	)		(212	)		—		(91	)		(204	)		—		(96	)		(216	)

Net derivative amounts	$	75,475	$	1,186		$	534		$	71,424	$	528		$	428		$	71,252	$	440		$	344

(a)	Netting adjustments represent the amounts recorded to convert our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance.

(b)

Other collateral represents the amount that cannot be used to offset our derivative assets and liabilities from a gross basis to a net basis in accordance with the applicable accounting guidance. The other collateral consists of securities and is exchanged under bilateral collateral and master netting agreements that allow us to offset the net derivative position with the related collateral. The application of the other collateral cannot reduce the net derivative position below zero. Therefore, excess other collateral, if any, is not reflected above.

Fair value hedges. Instruments designated as fair value hedges are recorded at fair value and included in “derivative assets” or “derivative liabilities” on the balance sheet. The effective portion of a change in the fair value of an instrument designated as a fair value hedge is recorded in earnings at the same time as a change in fair value of the hedged item, resulting in no effect on net income. The ineffective portion of a change in the fair value of such a hedging instrument is recorded in “other income” on the income statement with no corresponding offset. During the six-month period ended June 30, 2016, we did not exclude any portion of these hedging instruments from the assessment of hedge effectiveness. While there is some immaterial ineffectiveness in our hedging relationships, all of our fair value hedges remained “highly effective” as of June 30, 2016.

The following table summarizes the pre-tax net gains (losses) on our fair value hedges for the six-month periods ended June 30, 2016, and June 30, 2015, and where they are recorded on the income statement.

Six months ended June 30, 2016

in millions

Income Statement Location of

Net Gains (Losses) on Derivative

Net Gains
(Losses) on
Derivative

Hedged Item

Income Statement Location of
Net Gains (Losses) on Hedged Item

Net Gains
(Losses) on
Hedged Item

Interest rate

Other income

164

Long-term debt

Other income

(165

)^(a)

Interest rate

Interest expense — Long-term debt

Total

214

(165

)

Six months ended June 30, 2015

in millions

Income Statement Location of

Net Gains (Losses) on Derivative

Net Gains
(Losses) on
Derivative

Hedged Item

Income Statement Location of
Net Gains (Losses) on Hedged Item

Net Gains
(Losses) on
Hedged Item

Interest rate

Other income

(17

)

Long-term debt

Other income

^(a)

Interest rate

Interest expense — Long-term debt

Total

(a)	Net gains (losses) on hedged items represent the change in fair value caused by fluctuations in interest rates.

Cash flow hedges. Instruments designated as cash flow hedges are recorded at fair value and included in “derivative assets” or “derivative liabilities” on the balance sheet. Initially, the effective portion of a gain or loss on a cash flow hedge is recorded as a component of AOCI on the balance sheet. This amount is subsequently reclassified into income when the hedged transaction affects earnings (e.g., when we pay variable-rate interest on debt, receive variable-rate interest on commercial loans, or sell commercial real estate loans). The ineffective portion of cash flow hedging transactions is included in “other income” on the income statement. During the six-month period ended June 30, 2016, we did not exclude any portion of these hedging instruments from the assessment of hedge effectiveness. While there is some immaterial ineffectiveness in our hedging relationships, all of our cash flow hedges remained “highly effective” as of June 30, 2016.

Considering the interest rates, yield curves, and notional amounts as of June 30, 2016, we would expect to reclassify an estimated $45 million of after-tax net losses on derivative instruments from AOCI to income during the next 12 months for our cash flow hedges. In addition, we expect to reclassify approximately $2 million of net losses related to terminated cash flow hedges from AOCI to income during the next 12 months. As of June 30, 2016, the maximum length of time over which we hedge forecasted transactions is 12 years.

Net investment hedges. We enter into foreign currency forward contracts to hedge our exposure to changes in the carrying value of our investments as a result of changes in the related foreign exchange rates. Instruments designated as net investment hedges are recorded at fair value and included in “derivative assets” or “derivative liabilities” on the balance sheet. Initially, the effective portion of a gain or loss on a net investment hedge is recorded as a component of AOCI on the balance sheet when the terms of the derivative match the notional and currency risk being hedged. The effective portion is subsequently reclassified into income when the hedged transaction affects earnings (e.g., when we dispose of or liquidate a foreign subsidiary). At June 30, 2016, AOCI reflected unrecognized after-tax gains totaling $38 million related to cumulative changes in the fair value of our net investment hedges, which offset the unrecognized after-tax foreign currency losses on net investment balances. The ineffective portion of net investment hedging transactions is included in “other income” on the income statement, but there was no net investment hedge ineffectiveness as of June 30, 2016. We did not exclude any portion of our hedging instruments from the assessment of hedge effectiveness during the six-month period ended June 30, 2016.

The following table summarizes the pre-tax net gains (losses) on our cash flow and net investment hedges for the six-month periods ended June 30, 2016, and June 30, 2015, and where they are recorded on the income statement. The table includes the effective portion of net gains (losses) recognized in OCI during the period, the effective portion of net gains (losses) reclassified from OCI into income during the current period, and the portion of net gains (losses) recognized directly in income, representing the amount of hedge ineffectiveness.


	Six months ended June 30, 2016
in millions	Net Gains (Losses) Recognized in OCI (Effective Portion)			Income Statement Location of Net Gains (Losses) Reclassified From OCI Into Income (Effective Portion)	Net Gains (Losses) Reclassified From OCI Into Income (Effective Portion)			Income Statement Location of Net Gains (Losses) Recognized in Income (Ineffective Portion)	Net Gains (Losses) Recognized in Income (Ineffective Portion)
Cash Flow Hedges
Interest rate	$	204		Interest income — Loans	$	45		Other income		—
Interest rate		(6	)	Interest expense — Long-term debt		(2	)	Other income		—
Interest rate		(1	)	Investment banking and debt placement fees		—		Other income		—

Net Investment Hedges
Foreign exchange contracts		(5	)	Other Income		—		Other income		—

Total	$	192			$	43				—


	Six months ended June 30, 2015
in millions	Net Gains (Losses) Recognized in OCI (Effective Portion)			Income Statement Location of Net Gains (Losses) Reclassified From OCI Into Income (Effective Portion)	Net Gains (Losses) Reclassified From OCI Into Income (Effective Portion)			Income Statement Location of Net Gains (Losses) Recognized in Income (Ineffective Portion)	Net Gains (Losses) Recognized in Income (Ineffective Portion)
Cash Flow Hedges
Interest rate	$	48		Interest income — Loans	$	45		Other income		—
Interest rate		1		Interest expense — Long-term debt		(2	)	Other income		—
Interest rate		1		Investment banking and debt placement fees		—		Other income		—

Net Investment Hedges
Foreign exchange contracts		17		Other Income		—		Other income		—

Total	$	67			$	43				—

The after-tax change in AOCI resulting from cash flow and net investment hedges is as follows:


in millions	December 31, 2015		2016 Hedging Activity		Reclassification of Gains to Net Income			June 30, 2016
AOCI resulting from cash flow and net investment hedges	$	20	$	121	$	(27	)	$	114

Nonhedging instruments. Our derivatives that are not designated as hedging instruments are recorded at fair value in “derivative assets” and “derivative liabilities” on the balance sheet. Adjustments to the fair values of these instruments, as well as any premium paid or received, are included in “corporate services income” and “other income” on the income statement.

The following table summarizes the pre-tax net gains (losses) on our derivatives that are not designated as hedging instruments for the six-month periods ended June 30, 2016, and June 30, 2015, and where they are recorded on the income statement.


	Six months ended June 30, 2016								Six months ended June 30, 2015
in millions	Corporate Services Income		Other Income			Total			Corporate Services Income		Other Income			Total
NET GAINS (LOSSES)
Interest rate	$	13	$	(2	)	$	11		$	9		—		$	9
Foreign exchange		19		—			19			18		—			18
Commodity		2		—			2			3		—			3
Credit		1		(6	)		(5	)		—	$	(7	)		(7	)

Total net gains (losses)	$	35	$	(8	)	$	27		$	30	$	(7	)	$	23

Counterparty Credit Risk

Like other financial instruments, derivatives contain an element of credit risk. This risk is measured as the expected positive replacement value of the contracts. We use several means to mitigate and manage exposure to credit risk on derivative contracts. We generally enter into bilateral collateral and master netting agreements that provide for the net settlement of all contracts with a single counterparty in the event of default. Additionally, we monitor counterparty credit risk exposure on each contract to determine appropriate limits on our total credit exposure across all product types. We review our collateral positions on a daily basis and exchange collateral with our counterparties in accordance with standard ISDA documentation, central clearing rules, and other related agreements. We generally hold collateral in the form of cash and highly rated securities issued by the U.S. Treasury, government-sponsored enterprises, or GNMA. The cash collateral netted against derivative assets on the balance sheet totaled $241 million at June 30, 2016, $377 million at December 31, 2015, and $364 million at June 30, 2015. The cash collateral netted against derivative liabilities totaled $64 million at June 30, 2016, $5 million at December 31, 2015, and $16 million at June 30, 2015. The relevant agreements that allow us to access the central clearing organizations to clear derivative transactions are not considered to be qualified master netting agreements. Therefore, we cannot net derivative contracts or offset those contracts with related cash collateral with these counterparties. At June 30, 2016, we posted $491 million of cash collateral with clearing organizations and held $310 million of cash collateral from clearing organizations. At December 31, 2015, we posted $143 million of cash collateral with clearing organizations and held $6 million of cash collateral from clearing organizations. At June 30, 2015, we posted $114 million of cash collateral with clearing organizations and held $3 million of cash collateral from clearing organizations. This additional cash collateral is included in “accrued income and other assets” and “accrued expense and other liabilities” on the balance sheet.

The following table summarizes our largest exposure to an individual counterparty at the dates indicated.


in millions	June 30, 2016		December 31, 2015			June 30, 2015
Largest gross exposure (derivative asset) to an individual counterparty	$	135	$	158		$	105
Collateral posted by this counterparty		58		85			44
Derivative liability with this counterparty		122		74			90
Collateral pledged to this counterparty		57		—			37
Net exposure after netting adjustments and collateral		12		(1	)		8

The following table summarizes the fair value of our derivative assets by type at the dates indicated. These assets represent our gross exposure to potential loss after taking into account the effects of bilateral collateral and master netting agreements and other means used to mitigate risk.


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Interest rate	$	1,342	$	628	$	606
Foreign exchange		39		66		50
Commodity		91		298		243
Credit		3		4		1

Derivative assets before collateral		1,475		996		900
Less: Related collateral		241		377		364

Total derivative assets	$	1,234	$	619	$	536

We enter into derivative transactions with two primary groups: broker-dealers and banks, and clients. Since these groups have different economic characteristics, we have different methods for managing counterparty credit exposure and credit risk.

We enter into transactions with broker-dealers and banks for various risk management purposes. These types of transactions generally are high dollar volume. We generally enter into bilateral collateral and master netting agreements with these counterparties. We began clearing certain types of derivative transactions with these counterparties in June 2013, whereby the central clearing organizations become our counterparties subsequent to novation of the original derivative contracts. In addition, we began entering into derivative contracts through swap execution facilities during the first quarter of 2014. The swap clearing and swap trade execution requirements were mandated by the Dodd-Frank Act for the purpose of reducing counterparty credit risk and increasing transparency in the derivative market. At June 30, 2016, we had gross exposure of $886 million to broker-dealers and banks. We had net exposure of $571 million after the application of master netting agreements and cash collateral, where such qualifying agreements exist. We had net exposure of $506 million after considering $65 million of additional collateral held in the form of securities.

We enter into transactions with clients to accommodate their business needs. These types of transactions generally are low dollar volume. We generally enter into master netting agreements with these counterparties. In addition, we mitigate our overall portfolio exposure and market risk by buying and selling U.S. Treasuries and Eurodollar futures and entering into offsetting positions and other derivative contracts, sometimes with entities other than broker-dealers and banks. Due to the smaller size and magnitude of the individual contracts with clients, we generally do not exchange collateral in connection with these derivative transactions. To address the risk of default associated with the uncollateralized contracts, we have established a credit valuation adjustment (included in “derivative assets”) in the amount of $7 million at June 30, 2016, which we estimate to be the potential future losses on amounts due from client counterparties in the event of default. At June 30, 2016, we had gross exposure of $738 million to client counterparties and other entities that are not broker-dealers or banks for derivatives that have associated master netting agreements. We had net exposure of $663 million on our derivatives with these counterparties after the application of master netting agreements, collateral, and the related reserve. In addition, the derivatives for one counterparty were guaranteed by a third party with a letter of credit totaling $10 million.

Credit Derivatives

We are both a buyer and seller of credit protection through the credit derivative market. We purchase credit derivatives to manage the credit risk associated with specific commercial lending and swap obligations as well as exposures to debt securities. We may also sell credit derivatives, mainly single-name credit default swaps, to offset our purchased credit default swap positions prior to maturity.

The following table summarizes the fair value of our credit derivatives purchased and sold by type as of June 30, 2016, December 31, 2015, and June 30, 2015. The fair value of credit derivatives presented below does not take into account the effects of bilateral collateral or master netting agreements.


	June 30, 2016								December 31, 2015									June 30, 2015
in millions	Purchased			Sold		Net			Purchased			Sold			Net			Purchased			Sold			Net
Single-name credit default swaps	$	(2	)		—	$	(2	)	$	(3	)		—		$	(3	)	$	(2	)		—		$	(2	)
Traded credit default swap indices		2			—		2			4			—			4			2			—			2
Other ^(a)		—			—		—			—		$	(1	)		(1	)		—		$	(1	)		(1	)

Total credit derivatives		—			—		—		$	1		$	(1	)		—			—		$	(1	)	$	(1	)

(a)	As of June 30, 2016, the fair value of other credit derivatives sold totaled less than $1 million.

Single-name credit default swaps are bilateral contracts whereby the seller agrees, for a premium, to provide protection against the credit risk of a specific entity (the “reference entity”) in connection with a specific debt obligation. The protected credit risk is related to adverse credit events, such as bankruptcy, failure to make payments, and acceleration or restructuring of obligations, identified in the credit derivative contract. As the seller of a single-name credit derivative, we may settle in

one of two ways if the underlying reference entity experiences a predefined credit event. We may be required to pay the purchaser the difference between the par value and the market price of the debt obligation (cash settlement) or receive the specified referenced asset in exchange for payment of the par value (physical settlement). If we effect a physical settlement and receive our portion of the related debt obligation, we will join other creditors in the liquidation process, which may enable us to recover a portion of the amount paid under the credit default swap contract. We also may purchase offsetting credit derivatives for the same reference entity from third parties that will permit us to recover the amount we pay should a credit event occur.

A traded credit default swap index represents a position on a basket or portfolio of reference entities. As a seller of protection on a credit default swap index, we would be required to pay the purchaser if one or more of the entities in the index had a credit event. Upon a credit event, the amount payable is based on the percentage of the notional amount allocated to the specific defaulting entity.

The majority of transactions represented by the “other” category shown in the above table are risk participation agreements. In these transactions, the lead participant has a swap agreement with a customer. The lead participant (purchaser of protection) then enters into a risk participation agreement with a counterparty (seller of protection), under which the counterparty receives a fee to accept a portion of the lead participant’s credit risk. If the customer defaults on the swap contract, the counterparty to the risk participation agreement must reimburse the lead participant for the counterparty’s percentage of the positive fair value of the customer swap as of the default date. If the customer swap has a negative fair value, the counterparty has no reimbursement requirements. If the customer defaults on the swap contract and the seller fulfills its payment obligations under the risk participation agreement, the seller is entitled to a pro rata share of the lead participant’s claims against the customer under the terms of the swap agreement.

The following table provides information on the types of credit derivatives sold by us and held on the balance sheet at June 30, 2016, December 31, 2015, and June 30, 2015. The notional amount represents the maximum amount that the seller could be required to pay. The payment/performance risk assessment is based on the default probabilities for the underlying reference entities’ debt obligations using a Moody’s credit ratings matrix known as Moody’s “Idealized” Cumulative Default Rates. The payment/performance risk shown in the table represents a weighted-average of the default probabilities for all reference entities in the respective portfolios. These default probabilities are directly correlated to the probability that we will have to make a payment under the credit derivative contracts.


	June 30, 2016							December 31, 2015							June 30, 2015
dollars in millions	Notional Amount		Average Term (Years)		Payment / Performance Risk			Notional Amount		Average Term (Years)		Payment / Performance Risk			Notional Amount		Average Term (Years)		Payment / Performance Risk
Single-name credit default swaps		—		—		—			—		—		—		$	5		.22		.87	%
Other	$	25		16.60		8.95	%	$	5		2.67		14.46	%		6		2.51		8.36

Total credit derivatives sold	$	25		—		—		$	5		—		—		$	11		—		—

Credit Risk Contingent Features

We have entered into certain derivative contracts that require us to post collateral to the counterparties when these contracts are in a net liability position. The amount of collateral to be posted is based on the amount of the net liability and thresholds generally related to our long-term senior unsecured credit ratings with Moody’s and S&P. Collateral requirements also are based on minimum transfer amounts, which are specific to each Credit Support Annex (a component of the ISDA Master Agreement) that we have signed with the counterparties. In a limited number of instances, counterparties have the right to terminate their ISDA Master Agreements with us if our ratings fall below a certain level, usually investment-grade level (i.e., “Baa3” for Moody’s and “BBB-” for S&P). At June 30, 2016, KeyBank’s rating was “A3” with Moody’s and “A-” with S&P, and KeyCorp’s rating was “Baa1” with Moody’s and “BBB+” with S&P. As of June 30, 2016, the aggregate fair value of all derivative contracts with credit risk contingent features (i.e., those containing collateral posting or termination provisions based on our ratings) held by KeyBank that were in a net liability position totaled $261 million, which includes $241 million in derivative assets and $502 million in derivative liabilities. We had $265 million in cash and securities collateral posted to cover those positions as of June 30, 2016. The aggregate fair value of all derivative contracts with credit risk contingent features held by KeyCorp as of June 30, 2016, that were in a net liability position totaled $12 million, which consists solely of derivative liabilities. We had $12 million in collateral posted to cover those positions as of June 30, 2016.

The following table summarizes the additional cash and securities collateral that KeyBank would have been required to deliver under the ISDA Master Agreements had the credit risk contingent features been triggered for the derivative contracts in a net liability position as of June 30, 2016, December 31, 2015, and June 30, 2015. The additional collateral amounts were calculated based on scenarios under which KeyBank’s ratings are downgraded one, two, or three ratings as of June 30, 2016, December 31, 2015, and June 30, 2015, and take into account all collateral already posted. A similar calculation was

performed for KeyCorp, and no additional collateral would have been required as of June 30, 2016, December 31, 2015, or June 30, 2015. For more information about the credit ratings for KeyBank and KeyCorp, see the discussion under the heading “Factors affecting liquidity” in the section entitled “Liquidity risk management” in Item 2 of this report.


	June 30, 2016				December 31, 2015				June 30, 2015
in millions	Moody’s		S&P		Moody’s		S&P		Moody’s		S&P
KeyBank’s long-term senior unsecured credit ratings		A3		A-		A3		A-		A3		A-

One rating downgrade	$	2	$	2	$	2	$	2	$	4	$	4
Two rating downgrades		2		2		2		2		4		4
Three rating downgrades		2		2		4		4		6		6

KeyBank’s long-term senior unsecured credit rating was four ratings above noninvestment grade at Moody’s and S&P as of June 30, 2016, December 31, 2015, and June 30, 2015. If KeyBank’s ratings had been downgraded below investment grade as of June 30, 2016, December 31, 2015, or June 30, 2015, payments of up to $3 million, $5 million, and $7 million, respectively, would have been required to either terminate the contracts or post additional collateral for those contracts in a net liability position, taking into account all collateral already posted. If KeyCorp’s ratings had been downgraded below investment grade as of June 30, 2016, December 31, 2015, and June 30, 2015, payments of less than $1 million would have been required to either terminate the contracts or post additional collateral for those contracts in a net liability position, taking into account all collateral already posted.

8. Mortgage Servicing Assets

We originate and periodically sell commercial mortgage loans but continue to service those loans for the buyers. We also may purchase the right to service commercial mortgage loans for other lenders. We record a servicing asset if we purchase or retain the right to service loans in exchange for servicing fees that exceed the going market servicing rate and are considered more than adequate compensation for servicing. Mortgage servicing assets are recorded as a component of “accrued income and other assets” on the balance sheet. Changes in the carrying amount of mortgage servicing assets are summarized as follows:


	Three months ended June 30,						Six months ended June 30,
in millions	2016			2015			2016			2015
Balance at beginning of period	$	318		$	324		$	321		$	323
Servicing retained from loan sales		15			18			22			28
Purchases		—			10			12			25
Amortization		(10	)		(23	)		(32	)		(47	)

Balance at end of period	$	323		$	329		$	323		$	329

Fair value at end of period	$	404		$	423		$	404		$	423

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. The range and weighted-average of the significant unobservable inputs used to fair value our mortgage servicing assets at June 30, 2016, December 31, 2015, and June 30, 2015, along with the valuation techniques, are shown in the following table:


June 30, 2016 dollars in millions	Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
Mortgage servicing assets	Discounted cash flow	Prepayment speed	1.50 - 17.50% (4.20%)
		Expected defaults	1.00 - 3.00% (1.60%)
		Residual cash flows discount rate	7.00 - 15.00% (7.90%)
		Escrow earn rate	0.90 - 3.00% (2.10%)
		Servicing cost	$150 - $2,700 ($1,136)
		Loan assumption rate	0.00 - 3.00% (1.27%)
		Percentage late	0.00 - 2.10% (0.34%)

December 31, 2015 dollars in millions	Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
Mortgage servicing assets	Discounted cash flow	Prepayment speed	1.90 - 17.20% (4.60%)
		Expected defaults	1.00 - 3.00% (1.70%)
		Residual cash flows discount rate	7.00 - 15.00% (7.80%)
		Escrow earn rate	1.00 - 3.50% (2.30%)
		Servicing cost	$150 - $2,700 ($1,215)
		Loan assumption rate	0.00 - 3.00% (1.34%)
		Percentage late	0.00 - 2.00% (0.33%)

June 30, 2015 dollars in millions	Valuation Technique	Significant Unobservable Input	Range (Weighted-Average)
Mortgage servicing assets	Discounted cash flow	Prepayment speed	1.70 - 14.90% (4.70%)
		Expected defaults	1.00 - 3.00% (1.80%)
		Residual cash flows discount rate	7.00 - 15.00% (7.80%)
		Escrow earn rate	0.70 - 3.30% (2.00%)
		Servicing cost	$150 - $2,750 ($1,088)
		Loan assumption rate	0.20 - 3.00% (1.41%)
		Percentage late	0.00 - 2.00% (0.32%)

If these economic assumptions change or prove incorrect, the fair value of mortgage servicing assets may also change. Expected credit losses, escrow earn rates, and discount rates are critical to the valuation of servicing assets. Estimates of these assumptions are based on how a market participant would view the respective rates and reflect historical data associated with the loans, industry trends, and other considerations. Actual rates may differ from those estimated due to changes in a variety of economic factors. A decrease in the value assigned to the escrow earn rates would cause a decrease in the fair value of our mortgage servicing assets. An increase in the assumed default rates of commercial mortgage loans or an increase in the assigned discount rates would cause a decrease in the fair value of our mortgage servicing assets.

We have elected to account for servicing assets using the amortization method. The amortization of servicing assets is determined in proportion to, and over the period of, the estimated net servicing income. The amortization of servicing assets

for each period, as shown in the table at the beginning of this note, is recorded as a reduction to contractual fee income. The contractual fee income from servicing commercial mortgage loans totaled $66 million for the six-month period ended June 30, 2016, and $69 million for the six-month period ended June 30, 2015. This fee income was offset by $44 million of amortization for the six-month period ended June 30, 2016, and $47 million for the six-month period ended June 30, 2015. Both the contractual fee income and the amortization are recorded, net, in “mortgage servicing fees” on the income statement.

Additional information pertaining to the accounting for mortgage and other servicing assets is included in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Servicing Assets” on page 127 of our 2015 Form 10-K.

9. Variable Interest Entities

A VIE is a partnership, limited liability company, trust, or other legal entity that meets any one of the following criteria:

•

The entity does not have sufficient equity to conduct its activities without additional subordinated financial support from another party.

•

The entity’s investors lack the power to direct the activities that most significantly impact the entity’s economic performance.

•

The entity’s equity at risk holders do not have the obligation to absorb losses or the right to receive residual returns.

•

The voting rights of some investors are not proportional to their economic interests in the entity, and substantially all of the entity’s activities involve, or are conducted on behalf of, investors with disproportionately few voting rights.

Our significant VIEs are summarized below. We define a “significant interest” in a VIE as a subordinated interest that exposes us to a significant portion, but not the majority, of the VIE’s expected losses or residual returns, even though we do not have the power to direct the activities that most significantly impact the entity’s economic performance. KCC and KPP principal investments are newly assessed VIEs under the amended consolidation guidance. Additional information on the amended consolidation guidance is provided in Note 1 (“Basis of Presentation and Accounting Policies”).

LIHTC investments. Through KCDC, we have made investments directly and indirectly in LIHTC operating partnerships formed by third parties. As a limited partner in these operating partnerships, we are allocated tax credits and deductions associated with the underlying properties. We have determined that we are not the primary beneficiary of these investments because the general partners have the power to direct the activities that most significantly influence the economic performance of their respective partnerships and have the obligation to absorb expected losses and the right to receive residual returns. As we are not the primary beneficiary of these investments, we do not consolidate them.

Our maximum exposure to loss in connection with these partnerships consists of our unamortized investment balance plus any unfunded equity commitments and tax credits claimed but subject to recapture. We had $1 billion, $1.1 billion, and $996 million of investments in LIHTC operating partnerships at June 30, 2016, December 31, 2015, and June 30, 2015, respectively. These investments are recorded in “accrued income and other assets” on our balance sheet. We do not have any loss reserves recorded related to these investments because we believe the likelihood of any loss is remote. For all legally binding unfunded equity commitments, we increase our recognized investment and recognize a liability. As of June 30, 2016, December 31, 2015, and June 30, 2015, we had liabilities of $383 million, $410 million, and $333 million, respectively, related to investments in qualified affordable housing projects, which are recorded in “accrued expenses and other liabilities” on our balance sheet. We continue to invest in these LIHTC operating partnerships.

The assets and liabilities presented in the table below convey the size of KCDC’s direct and indirect investments at June 30, 2016, December 31, 2015, and June 30, 2015. As these investments represent unconsolidated VIEs, the assets and liabilities of the investments themselves are not recorded on our balance sheet. During 2015, we noted that not all of KCDC’s unconsolidated VIEs were captured in the table below. As a result, the amounts in the table were revised to incorporate all of KCDC’s unconsolidated VIEs for the quarter ended June 30, 2015. Because our LIHTC investments were appropriately accounted for, these revisions did not impact our financial condition or results of operations for the quarter ended June 30, 2015.


	Unconsolidated VIEs
in millions	Total Assets		Total Liabilities		Maximum Exposure to Loss
June 30, 2016
LIHTC investments	$	4,650	$	1,909	$	1,232
December 31, 2015
LIHTC investments	$	4,914	$	1,368	$	1,332
June 30, 2015
LIHTC investments	$	3,338	$	552	$	1,175

We amortize our LIHTC investments over the period that we expect to receive the tax benefits. During the first six months of 2016, we recognized $64 million of amortization and $67 million of tax credits associated with these investments within “income taxes” on our income statement. During the first six months of 2015, we recognized $56 million of amortization and $64 million of tax credits associated with these investments within “income taxes” on our income statement.

Principal investments. Through our principal investing entity, KCC, we have made investments in private equity funds engaged in venture- and growth-oriented investing. As a limited partner to these funds, KCC records these investments at fair value and receives distributions from the funds in accordance with the funds’ partnership agreements. We are not the primary beneficiary of these investments as we do not hold the power to direct the activities that most significantly affect the funds’ economic performance. Such power rests with the funds’ general partners. In addition, we neither have the obligation to absorb the funds’ expected losses nor the right to receive their residual returns. Our voting rights are also disproportionate to our economic interests, and substantially all of the funds’ activities are conducted on behalf of investors with disproportionally few voting rights. Because we are not the primary beneficiary of these investments, we do not consolidate them.

Our maximum exposure to loss associated with indirect principal investments consists of the investments’ fair value plus any unfunded equity commitments. The fair value of our indirect principal investments totaled $184 million, $235 million, and $282 million at June 30, 2016, December 31, 2015, and June 30, 2015, respectively. These investments are recorded in “other investments” on our balance sheet. Additional information on indirect principal investments is provided in Note 5 (“Fair Value Measurements”). The table below reflects the size of the private equity funds in which KCC was invested as well as our maximum exposure to loss in connection with these investments at June 30, 2016.

Unconsolidated VIEs

in millions

Total
Assets

Total
Liabilities

Maximum
Exposure to Loss

June 30, 2016

KCC indirect investments

32,861

203

228

Other unconsolidated VIEs. We are involved with other various entities in the normal course of business that we have determined to be VIEs. We have determined that we are not the primary beneficiary of these partnerships because the general partners have the power to direct the activities that most significantly impact their economic performance. Our assets associated with these unconsolidated VIEs totaled $142 million at June 30, 2016, $176 million at December 31, 2015, and $194 million at June 30, 2015, and primarily consisted of our investments in these entities. These assets are recorded in “accrued income and other assets,” “other investments,” and “securities available for sale” on our balance sheet. We had no liabilities associated with these unconsolidated VIEs at June 30, 2016, and less than $1 million December 31, 2015, and June 30, 2015. These liabilities are recorded in “accrued expenses and other liabilities” on our balance sheet.

Consolidated VIEs. Through our principal investing entity, KPP, we have formed and funded operating entities that provide management and other related services to our investment company funds, which directly invest in portfolio companies. In return for providing services to our direct investment funds, these entities’ receive a minority equity interest in the funds. This minority equity ownership is recorded at fair value on the entities’ financial statements. Additional information on our direct principal investments is provided in Note 5 (“Fair Value Measurements”). While other equity investors manage the daily operations of these entities, we retain the power, through voting rights, to direct the activities of the entities that most significantly impact their economic performance. In addition, we have the obligation to absorb losses and the right to receive residual returns that could potentially be significant to these entities. As a result, we have determined that we are the primary beneficiary of these funds and have consolidated them since formation. The assets of these KPP entities that can only be used to settle the entities’ obligations totaled $7 million, $7 million, and $6 million at June 30, 2016, December 31, 2015, and June 30, 2015, respectively. These assets are recorded in “cash and due from banks” and “accrued income and other assets” on our balance sheet. The entities had no liabilities at June 30, 2016, December 31, 2015, and June 30, 2015, and other equity investors have no recourse to our general credit.

10. Income Taxes

Income Tax Provision

In accordance with the applicable accounting guidance, the principal method established for computing the provision for income taxes in interim periods requires us to make our best estimate of the effective tax rate expected to be applicable for the full year. This estimated effective tax rate is then applied to interim consolidated pre-tax operating income to determine the interim provision for income taxes.

The effective tax rate, which is the provision for income taxes as a percentage of income from continuing operations before income taxes, was 25.6% for the second quarter of 2016 and 26.3% for the second quarter of 2015. The effective tax rates are below our combined federal and state statutory tax rate of 37.2% primarily due to income from investments in tax-advantaged assets such as corporate-owned life insurance and credits associated with renewable energy and low-income housing investments.

Deferred Tax Asset

At June 30, 2016, from continuing operations, we had a net federal deferred tax asset of $75 million and a net state deferred tax asset of $12 million, compared to a net federal deferred tax asset of $269 million and a net state deferred tax asset of $30 million at December 31, 2015, and a net federal deferred tax asset of $195 million and a net state deferred tax asset of $24 million at June 30, 2015, included in “accrued income and other assets” on the balance sheet. To determine the amount of deferred tax assets that are more-likely-than-not to be realized, and therefore recorded, we conduct a quarterly assessment of all available evidence. This evidence includes, but is not limited to, taxable income in prior periods, projected future taxable income, and projected future reversals of deferred tax items. These assessments involve a degree of subjectivity and may undergo change. Based on these criteria, we had a valuation allowance of less than $1 million at June 30, 2016, December 31, 2015, and June 30, 2015, associated with certain state net operating loss carryforwards and state credit carryforwards.

Unrecognized Tax Benefits

As permitted under the applicable accounting guidance for income taxes, it is our policy to recognize interest and penalties related to unrecognized tax benefits in income tax expense.

Deferred tax assets were reduced in the financial statements for unrecognized tax benefits by $2.7 million at June 30, 2016, $2.7 million at December 31, 2015, and less than $1 million at June 30, 2015.

11. Acquisitions and Discontinued Operations

Acquisitions

First Niagara Financial Group, Inc. As previously disclosed, on October 30, 2015, KeyCorp entered into a definitive agreement and plan of merger (“Agreement”) to acquire all of the outstanding capital stock of First Niagara, headquartered in Buffalo, New York. Under the terms of the Agreement, at the effective time of the merger, each share of First Niagara common stock is converted into the right to receive (i) 0.680 of a share of KeyCorp common stock and (ii) $2.30 in cash. The exchange ratio of KeyCorp stock for First Niagara stock is fixed and does not adjust based on changes in KeyCorp’s share trading price. First Niagara equity awards outstanding immediately prior to the effective time of the merger are converted into equity awards for KeyCorp common stock as provided in the Agreement. Each share of First Niagara’s Fixed-to-Floating Rate Perpetual Non-Cumulative Preferred Stock, Series B, is converted into a share of a newly created series of preferred stock of KeyCorp having substantially the same terms as First Niagara’s preferred stock.

On April 28, 2016, KeyCorp and First Niagara entered into an agreement with Northwest Bank, a wholly-owned subsidiary of Northwest Bancshares, Inc., to sell 18 branches in the Buffalo, New York market. The branches are being divested in connection with the merger between First Niagara and KeyCorp and pursuant to an agreement with the United States Department of Justice and commitments to the Board of Governors of the Federal Reserve System following a customary antitrust review in connection with the merger. On July 12, 2016, KeyCorp received regulatory approval from the Federal Reserve to complete the merger with First Niagara.

On August 1, 2016, First Niagara merged with and into KeyCorp, with KeyCorp as the surviving entity. The total consideration for the transaction was approximately $4.0 billion.

As of June 30, 2016, First Niagara, headquartered in Buffalo, New York, had approximately 390 branches with $40 billion of total assets and $29 billion of deposits.

Discontinued operations

Education lending. In September 2009, we decided to exit the government-guaranteed education lending business. As a result, we have accounted for this business as a discontinued operation.

As of January 1, 2010, we consolidated our 10 outstanding education lending securitization trusts since we held the residual interests and are the master servicer with the power to direct the activities that most significantly influence the economic performance of the trusts.

On September 30, 2014, we sold the residual interests in all of our outstanding education lending securitization trusts to a third party for $57 million. In selling the residual interests, we no longer have the obligation to absorb losses or the right to receive benefits related to the securitization trusts. Therefore, in accordance with the applicable accounting guidance, we deconsolidated the securitization trusts and removed trust assets of $1.7 billion and trust liabilities of $1.6 billion from our balance sheet at September 30, 2014. We continue to service the securitized loans in eight of the securitization trusts and receive servicing fees, whereby we are adequately compensated, as well as remain a counterparty to derivative contracts with three of the securitization trusts. We retained interests in the securitization trusts through our ownership of an insignificant percentage of certificates in two of the securitization trusts and two interest-only strips in one of the securitization trusts. These retained interests were remeasured at fair value on September 30, 2014, and their fair value of $1 million was recorded in “discontinued assets” on our balance sheet. These assets were valued using a similar approach and inputs that have been used to value the education loan securitization trust loans and securities, which are further discussed later in this note.

“Income (loss) from discontinued operations, net of taxes” on the income statement includes (i) the changes in fair value of the portfolio loans at fair value (discussed later in this note), and (ii) the interest income and expense from the loans in portfolio at both amortized cost and fair value. These amounts are shown separately in the following table. Gains and losses attributable to changes in fair value are recorded as a component of “noninterest income” or “noninterest expense.” Interest income and interest expense related to the loans and securities are included as components of “net interest income.”

The components of “income (loss) from discontinued operations, net of taxes” for the education lending business are as follows:


	Three months ended June 30,					Six months ended June 30,
in millions	2016		2015			2016		2015
Net interest income	$	7	$	10		$	14	$	20
Provision for credit losses		—		—			2		2

Net interest income after provision for credit losses		7		10			12		18
Noninterest income		2		(1	)		3		3
Noninterest expense		4		4			9		8

Income (loss) before income taxes		5		5			6		13
Income taxes		2		2			2		5

Income (loss) from discontinued operations, net of taxes ^(a)	$	3	$	3		$	4	$	8

(a)

Includes after-tax charges of $6 million and $5 million for the three-month periods ended June 30, 2016, and June 30, 2015, respectively, and $12 million and $11 million for the six-month periods ended June 30, 2016, and June 30, 2015, respectively, determined by applying a matched funds transfer pricing methodology to the liabilities assumed necessary to support the discontinued operations.

The discontinued assets of our education lending business included on the balance sheet are as follows. There were no discontinued liabilities for the periods presented below.


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Held-to-maturity securities	$	1	$	1	$	1
Portfolio loans at fair value		3		4		—
Loans, net of unearned income^(a)		1,689		1,824		1,962
Less: Allowance for loan and lease losses		20		28		22

Net loans		1,672		1,800		1,940
Portfolio loans held for sale at fair value		—		—		179
Accrued income and other assets		29		30		34

Total assets	$	1,702	$	1,831	$	2,154

(a)	At June 30, 2016, December 31, 2015, and June 30, 2015, unearned income was less than $1 million.

The discontinued education lending business consisted of loans in portfolio (recorded at fair value) and loans in portfolio (recorded at carrying value with appropriate valuation reserves). As of June 30, 2015, we decided to sell the portfolio loans that are recorded at fair value, which were subsequently sold during the fourth quarter of 2015.

At June 30, 2016, education loans included 2,077 TDRs with a recorded investment of approximately $22 million (pre-modification and post-modification). A specifically allocated allowance of $2 million was assigned to these loans as of June 30, 2016. At December 31, 2015, education loans included 1,901 TDRs with a recorded investment of approximately $21 million (pre-modification and post-modification). A specifically allocated allowance of $2 million was assigned to these loans as of December 31, 2015. At June 30, 2015, education loans included 1,767 TDRs with a recorded investment of approximately $19 million (pre-modification and post-modification). A specifically allocated allowance of $1 million was assigned to these loans at June 30, 2015. There have been no significant payment defaults. There are no significant commitments outstanding to lend additional funds to these borrowers. Additional information regarding TDR classification and ALLL methodology is provided in Note 5 (“Asset Quality”).

On June 27, 2014, we purchased the private loans from one of the education loan securitization trusts through the execution of a clean-up call option. The trust used the cash proceeds from the sale of these loans to retire the outstanding securities related to these private loans, and there are no future commitments or obligations to the holders of the securities. The portfolio loans were valued using an internal discounted cash flow method, which was affected by assumptions for defaults, expected credit losses, discount rates, and prepayments. The portfolio loans are considered to be Level 3 assets since we rely on unobservable inputs when determining fair value.

In June 2015, we transferred $179 million of loans that were previously purchased from three of the outstanding securitizations trusts pursuant to the legal terms of those particular trusts to held for sale and accounted for them at fair value. These portfolio loans held for sale were valued based on indicative bids to sell the loans. These portfolio loans were previously valued using an internal discounted cash flow model, which was affected by assumptions for defaults, loss severity, discount rates, and prepayments. These loans were considered Level 3 assets since we relied on unobservable inputs when determining their fair value. Our valuation process for these loans prior to June 2015 is discussed in more detail

below. On October 29, 2015, government-guaranteed loans were sold for $117 million. On December 8, 2015, private loans were sold for $45 million. The gain on the sales of these loans was $1 million. The remaining portfolio loans held for sale, totaling $4 million, were reclassified to portfolio loans at fair value at December 31, 2015. Portfolio loans accounted for at fair value were $3 million at June 30, 2016.

Corporate Treasury, within our Finance area, was responsible for the quarterly valuation process that previously determined the fair value of our student loans held in portfolio that were accounted for at fair value. Corporate Treasury provided these fair values to a Working Group Committee (the “Working Group”) comprising representatives from the line of business, Credit and Market Risk Management, Accounting, Business Finance (part of our Finance area), and Corporate Treasury. The Working Group was a subcommittee of the Fair Value Committee that is discussed in more detail in Note 5 (“Fair Value Measurements”). The Working Group reviewed all significant inputs and assumptions and approved the resulting fair values.

The Working Group reviewed actual performance trends of the loans on a quarterly basis and used statistical analysis and qualitative measures to determine assumptions for future performance. Predictive models that incorporate delinquency and charge-off trends along with economic outlooks assisted the Working Group to forecast future defaults. The Working Group used this information to formulate the credit outlook related to the loans. Higher projected defaults, fewer expected recoveries, elevated prepayment speeds, and higher discount rates would be expected to result in a lower fair value of the portfolio loans. Default expectations and discount rate changes had the most significant impact on the fair values of the loans. Increased cash flow uncertainty, whether through higher defaults and prepayments or fewer recoveries, can result in higher discount rates for use in the fair value process for these loans.

The valuation process for the portfolio loans that were accounted for at fair value was based on a discounted cash flow analysis using a model purchased from a third party and maintained by Corporate Treasury. The valuation process began with loan-level data that was aggregated into pools based on underlying loan structural characteristics (i.e., current unpaid principal balance, contractual term, interest rate). Cash flows for these loan pools were developed using a financial model that reflected certain assumptions for defaults, recoveries, status changes, and prepayments. A net earnings stream, taking into account cost of funding, was calculated and discounted back to the measurement date using an appropriate discount rate. This resulting amount was used to determine the present value of the loans, which represented their fair value to a market participant.

The unobservable inputs set forth in the following table were reviewed and approved by the Working Group on a quarterly basis. As of December 31, 2015, the portfolio loans accounted for at fair value were valued based on the indicative bids we received when we sold $162 million of these loans in late 2015.

A quarterly variance analysis reconciled valuation changes in the model used to calculate the fair value of the portfolio loans at fair value. This quarterly analysis considered loan run-off, yields, and future default and recovery changes. We also performed back-testing to compare expected defaults to actual experience; the impact of future defaults could significantly affect the fair value of these loans over time. In addition, our internal model validation group periodically performed a review to ensure the accuracy and validity of the model for determining the fair value of these loans.

The following table shows the significant unobservable inputs used to measure the fair value of the portfolio loans accounted for at fair value as of June 30, 2016, December 31, 2015, and June 30, 2015:

June 30, 2016

dollars in millions

Fair Value of Level 3
Assets and Liabilities

Valuation
Technique

Significant
Unobservable Input

Range
(Weighted-Average)

Portfolio loans accounted for at fair value

Market approach

Indicative bids

84.50-104.00

December 31, 2015

dollars in millions

Fair Value of Level 3
Assets and Liabilities

Valuation
Technique

Significant
Unobservable Input

Range
(Weighted-Average)

Portfolio loans accounted for at fair value

Market approach

Indicative bids

84.50-104.00

June 30, 2015

dollars in millions

Fair Value of Level 3
Assets and Liabilities

Valuation
Technique

Significant
Unobservable Input

Range
(Weighted-Average)

Portfolio loans held for sale accounted for at fair value

179

Market approach

Indicative bids

88.24-105.55

The following table shows the principal and fair value amounts for our portfolio loans at carrying value and portfolio loans at fair value at June 30, 2016, December 31, 2015, and June 30, 2015. Our policies for determining past due loans, placing loans on nonaccrual, applying payments on nonaccrual loans, and resuming accrual of interest are disclosed in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Nonperforming Loans” beginning on page 121 of our 2015 Form 10-K.


	June 30, 2016				December 31, 2015				June 30, 2015
in millions	Principal		Fair Value		Principal		Fair Value		Principal		Fair Value
Portfolio loans at carrying value
Accruing loans past due 90 days or more	$	21		N/A	$	26		N/A	$	26		N/A
Loans placed on nonaccrual status		5		N/A		8		N/A		6		N/A
Portfolio loans at fair value
Accruing loans past due 90 days or more		—		—	$	1	$	1		—		—
Loans placed on nonaccrual status		—		—		—		—		—		—
Portfolio loans held for sale at fair value
Accruing loans past due 90 days or more		—		—		—		—	$	5	$	5

The following table shows the portfolio loans at fair value and their related contractual amounts as of June 30, 2016, December 31, 2015, and June 30, 2015.


	June 30, 2016				December 31, 2015				June 30, 2015
in millions	Contractual Amount		Fair Value		Contractual Amount		Fair Value		Contractual Amount		Fair Value
ASSETS
Portfolio loans	$	3	$	3	$	4	$	4		—		—
Portfolio loans held for sale		—		—		—		—	$	179	$	179

The following tables present the assets of the portfolio loans measured at fair value on a recurring basis at June 30, 2016, December 31, 2015, and June 30, 2015.


June 30, 2016 in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans		—		—	$	3	$	3

Total assets on a recurring basis at fair value		—		—	$	3	$	3


December 31, 2015 in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans		—		—	$	4	$	4

Total assets on a recurring basis at fair value		—		—	$	4	$	4


June 30, 2015 in millions	Level 1		Level 2		Level 3		Total
ASSETS MEASURED ON A RECURRING BASIS
Portfolio loans held for sale		—		—	$	179	$	179

Total assets on a recurring basis at fair value		—		—	$	179	$	179

The following table shows the change in the fair values of the Level 3 portfolio loans held for sale, portfolio loans, and consolidated education loan securitization trusts for the three- and six-month periods ended June 30, 2016, and June 30, 2015.


in millions	Portfolio Student Loans Held For Sale		Portfolio Student Loans
Balance at December 31, 2015		—	$	4
Settlements		—		(1	)

Balance at June 30, 2016^(a)		—	$	3

Balance at March 31, 2016		—	$	3
Settlements		—		—

Balance at June 30, 2016		—	$	3

Balance at December 31, 2014		—	$	191
Gains (losses) recognized in earnings^(b)		—		1
Settlements		—		(13	)
Loans transferred to held for sale	$	179		(179	)

Balance at June 30, 2015^(a)	$	179		—

Balance at March 31, 2015		—	$	187
Gains (losses) recognized in earnings^(b)		—		(2	)
Settlements		—		(6	)
Loans transferred to held for sale	$	179		(179	)

Balance at June 30, 2015^(a)	$	179		—

(a)

There were no purchases, sales, issuances, gains (losses) recognized in earnings, transfers into Level 3, or transfers out of Level 3 for the three- and six-month periods ended June 30, 2016. There were no purchases, sales, issuances, transfers into Level 3, or transfers out of Level 3 for the three- and six-month periods ended and June 30, 2015.

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

Austin Capital Management, Ltd. In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. As a result, we have accounted for this business as a discontinued operation.

There was no income related to Austin for the three- and six-month periods ended June 30, 2016, and June 30, 2015.

The discontinued assets of Austin included on the balance sheet are as follows. There were no discontinued liabilities for the periods presented below.


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Cash and due from banks	$	15	$	15	$	15

Total assets	$	15	$	15	$	15

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


	Three months ended June 30,					Six months ended June 30,
in millions	2016		2015			2016		2015
Net interest income	$	7	$	10		$	14	$	20
Provision for credit losses		—		—			2		2

Net interest income after provision for credit losses		7		10			12		18
Noninterest income		2		(1	)		3		3
Noninterest expense		4		4			9		8

Income (loss) before income taxes		5		5			6		13
Income taxes		2		2			2		5

Income (loss) from discontinued operations, net of taxes ^(a)	$	3	$	3		$	4	$	8

(a)

The combined assets of the discontinued operations are as follows. There were no discontinued liabilities for the periods presented below.


in millions	June 30, 2016		December 31, 2015		June 30, 2015
Cash and due from banks	$	15	$	15	$	15
Held-to-maturity securities		1		1		1
Portfolio loans at fair value		3		4		—
Loans, net of unearned income^(a)		1,689		1,824		1,962
Less: Allowance for loan and lease losses		20		28		22

Net loans		1,672		1,800		1,940
Portfolio loans held for sale at fair value		—		—		179
Accrued income and other assets		29		30		34

Total assets	$	1,717	$	1,846	$	2,169

(a)	At June 30, 2016, December 31, 2015, and June 30, 2015, unearned income was less than $1 million.

12. Securities Financing Activities

We enter into repurchase and reverse repurchase agreements and securities borrowed transactions (securities financing agreements) primarily to finance our inventory positions, acquire securities to cover short positions, and to settle other securities obligations. We account for these securities financing agreements as collateralized financing transactions. Repurchase and reverse repurchase agreements are recorded on the balance sheet at the amounts that the securities will be subsequently sold or repurchased. Securities borrowed transactions are recorded on the balance sheet at the amounts of cash collateral advanced. While our securities financing agreements incorporate a right of set off, the assets and liabilities are reported on a gross basis. Reverse repurchase agreements and securities borrowed transactions are included in “short-term investments” on the balance sheet; repurchase agreements are included in “federal funds purchased and securities sold under repurchase agreements.”

The following table summarizes our securities financing agreements at June 30, 2016, December 31, 2015, and June 30, 2015:


	June 30, 2016
in millions	Gross Amount Presented in Balance Sheet		Netting Adjustments^(a)			Collateral^(b)			Net Amounts
Offsetting of financial assets:
Reverse repurchase agreements	$	1	$	(1	)		—			—

Total	$	1	$	(1	)		—			—

Offsetting of financial liabilities:
Repurchase agreements^(c)	$	1	$	(1	)		—			—

Total	$	1	$	(1	)		—			—


	December 31, 2015
in millions	Gross Amount Presented in Balance Sheet		Netting Adjustments^(a)			Collateral^(b)			Net Amounts
Offsetting of financial assets:
Reverse repurchase agreements	$	1		—		$	(1	)		—

Total	$	1		—		$	(1	)		—

Offsetting of financial liabilities:
Repurchase agreements^(c)		—		—			—			—

Total		—		—			—			—


	June 30, 2015
in millions	Gross Amount Presented in Balance Sheet		Netting Adjustments^(a)			Collateral^(b)			Net Amounts
Offsetting of financial assets:
Reverse repurchase agreements	$	3	$	(3	)		—			—

Total	$	3	$	(3	)		—			—

Offsetting of financial liabilities:
Repurchase agreements	$	4	$	(3	)	$	(1	)		—

Total	$	4	$	(3	)	$	(1	)		—

(a)	Netting adjustments take into account the impact of master netting agreements that allow us to settle with a single counterparty on a net basis.

(b)	These adjustments take into account the impact of bilateral collateral agreements that allow us to offset the net positions with the related collateral. The application of collateral cannot reduce the net position below zero. Therefore, excess collateral, if any, is not reflected above.

(c)	Repurchase agreements are collateralized by U.S. Treasury securities and contracted on an overnight basis.

Like other financing transactions, securities financing agreements contain an element of credit risk. To mitigate and manage credit risk exposure, we generally enter into master netting agreements and other collateral arrangements that give us the right, in the event of default, to liquidate collateral held and to offset receivables and payables with the same counterparty. Additionally, we establish and monitor limits on our counterparty credit risk exposure by product type. For the reverse repurchase agreements, we monitor the value of the underlying securities we received from counterparties and either request additional collateral or return a portion of the collateral based on the value of those securities. We generally hold collateral in the form of highly rated securities issued by the U.S. Treasury and fixed income securities. In addition, we may need to provide collateral to counterparties under our repurchase agreements and securities borrowed transactions. In general, the collateral we pledge and receive can be sold or repledged by the secured parties.

13. Employee Benefits

Pension Plans

Effective December 31, 2009, we amended our cash balance pension plan and other defined benefit plans to freeze all benefit accruals and close the plans to new employees. We will continue to credit participants’ existing account balances for interest until they receive their plan benefits. We changed certain pension plan assumptions after freezing the plans.

The components of net pension cost (benefit) for all funded and unfunded plans are as follows:


	Three months ended June 30,						Six months ended June 30,
in millions	2016			2015			2016			2015
Interest cost on PBO	$	11		$	10		$	21		$	20
Expected return on plan assets		(13	)		(14	)		(26	)		(28	)
Amortization of losses		4			5			8			9

Net pension cost	$	2		$	1		$	3		$	1

Other Postretirement Benefit Plans

We sponsor a retiree healthcare plan that all employees age 55 with five years of service (or employees age 50 with 15 years of service who are terminated under conditions that entitle them to a severance benefit) are eligible to participate. Participant contributions are adjusted annually. We may provide a subsidy toward the cost of coverage for certain employees hired before 2001 with a minimum of 15 years of service at the time of termination. We use a separate VEBA trust to fund the retiree healthcare plan.

The components of net postretirement benefit cost for all funded and unfunded plans are as follows:


	Three months ended June 30,						Six months ended June 30,
in millions	2016			2015			2016			2015
Interest cost on APBO	$	1		$	1		$	2		$	2
Expected return on plan assets		(1	)		—			(2	)		(1	)
Amortization of unrecognized prior service credit		—			(1	)		—			(1	)

Net postretirement benefit cost		—			—			—			—

14. Trust Preferred Securities Issued by Unconsolidated Subsidiaries

We own the outstanding common stock of business trusts formed by us that issued corporation-obligated mandatorily redeemable trust preferred securities. The trusts used the proceeds from the issuance of their trust preferred 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 mandatorily redeemable trust preferred securities. The outstanding common stock of these business trusts is recorded in “other investments” on our balance sheet.

We unconditionally guarantee the following payments or distributions on behalf of the trusts:

•

required distributions on the trust preferred securities;

•

the redemption price when a capital security is redeemed; and

•

the amounts due if a trust is liquidated or terminated.

The Regulatory Capital Rules, discussed in “Supervision and regulation” in Item 2 of this report, implement a phase-out of trust preferred securities as Tier 1 capital, consistent with the requirements of the Dodd-Frank Act. For “standardized approach” banking organizations such as Key, the phase-out period began on January 1, 2015, and starting in 2016 requires us to treat our mandatorily redeemable trust preferred securities as Tier 2 capital.

The trust preferred securities, common stock, and related debentures are summarized as follows:


dollars in millions	Trust Preferred Securities, Net of Discount ^(a)		Common Stock		Principal Amount of Debentures, Net of Discount ^(b)		Interest Rate of Trust Preferred Securities and Debentures ^(c)			Maturity of Trust Preferred Securities and Debentures
June 30, 2016
KeyCorp Capital I	$	156	$	6	$	162		1.365	%		2028
KeyCorp Capital II		117		4		121		6.875			2029
KeyCorp Capital III		151		4		155		7.750			2029

Total	$	424	$	14	$	438		5.159	%		—

December 31, 2015	$	408	$	14	$	422		4.961	%		—

June 30, 2015	$	402	$	14	$	416		4.903	%		—

(a)

The trust preferred securities must be redeemed when the related debentures mature, or earlier if provided in the governing indenture. Each issue of trust preferred securities carries an interest rate identical to that of the related debenture. Certain trust preferred securities include basis adjustments related to fair value hedges totaling $84 million at June 30, 2016, $68 million at December 31, 2015, and $62 million at June 30, 2015. See Note 7 (“Derivatives and Hedging Activities”) for an explanation of fair value hedges.

(b)

We have the right to redeem these debentures. If the debentures purchased by KeyCorp Capital I are redeemed before they mature, the redemption price will be the principal amount, plus any accrued but unpaid interest. If the debentures purchased by KeyCorp Capital II or KeyCorp Capital III are redeemed before they mature, the redemption price will be the greater of: (i) the principal amount, plus any accrued but unpaid interest, or (ii) 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 for KeyCorp Capital II or 25 basis points for KeyCorp Capital III or 50 basis points in the case of redemption upon either a tax or a capital treatment event for either KeyCorp Capital II or KeyCorp Capital III, plus any accrued but unpaid interest. The principal amount of certain debentures includes basis adjustments related to fair value hedges totaling $84 million at June 30, 2016, $68 million at December 31, 2015, and $62 million at June 30, 2015. See Note 7 for an explanation of fair value hedges. The principal amount of debentures, net of discounts, is included in “long-term debt” on the balance sheet.

(c)

The interest rates for the trust preferred securities issued by KeyCorp Capital II and KeyCorp Capital III are fixed. The trust preferred securities issued by KeyCorp Capital I have a floating interest rate, equal to three-month LIBOR plus 74 basis points, that reprices quarterly. The total interest rates are weighted-average rates.

15. Contingent Liabilities and Guarantees

Legal Proceedings

See Note 20 (“Commitments, Contingent Liabilities and Guarantees”) under the heading “Legal Proceedings” on page 211 of our 2015 Form 10-K for a description of a proceeding styled In re: Checking Account Overdraft Litigation.

Other litigation. From time to time, in the ordinary course of business, we and our subsidiaries are subject to various other litigation, investigations, and administrative proceedings. Private, civil litigations may range from individual actions involving a single plaintiff to putative class action lawsuits with potentially thousands of class members. Investigations may involve both formal and informal proceedings, by both government agencies and self-regulatory bodies. These other matters may involve claims for substantial monetary relief. At times, these matters may present novel claims or legal theories. Due to the complex nature of these various other matters, it may be years before some matters are resolved. While it is impossible to ascertain the ultimate resolution or range of financial liability, based on information presently known to us, we do not believe there is any other matter to which we are a party, or involving any of our properties that, individually or in the aggregate, would reasonably be expected to have a material adverse effect on our financial condition. We continually monitor and reassess the potential materiality of these other litigation matters. We note, however, that in light of the inherent uncertainty in legal proceedings there can be no assurance that the ultimate resolution will not exceed established reserves. As a result, the outcome of a particular matter, or a combination of matters, may be material to our results of operations for a particular period, depending upon the size of the loss or our income for that particular period.

Guarantees

We are a guarantor in various agreements with third parties. The following table shows the types of guarantees that we had outstanding at June 30, 2016. 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” beginning on page 130 of our 2015 Form 10-K.


June 30, 2016 in millions	Maximum Potential Undiscounted Future Payments		Liability Recorded
Financial guarantees:
Standby letters of credit	$	11,140	$	67
Recourse agreement with FNMA		1,956		4
Return guarantee agreement with LIHTC investors		3		3
Written put options^(a)		2,661		47

Total	$	15,760	$	121

(a)	The maximum potential undiscounted future payments represent notional amounts of derivatives qualifying as guarantees.

We determine the payment/performance risk associated with each type of guarantee described below based on the probability that we could be required to make the maximum potential undiscounted future payments shown in the preceding table. We use a scale of low (0% to 30% probability of payment), moderate (greater than 30% to 70% probability of payment), or high (greater than 70% probability of payment) to assess the payment/performance risk, and have determined that the payment/performance risk associated with each type of guarantee outstanding at June 30, 2016, is low.

Standby letters of credit. KeyBank issues standby letters of credit to address clients’ financing needs. These instruments obligate us 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 to the client; they bear interest (generally at variable rates) and pose the same credit risk to us as a loan. At June 30, 2016, our standby letters of credit had a remaining weighted-average life of 2.9 years, with remaining actual lives ranging from less than one year to as many as 11 years.

Recourse agreement with FNMA. We participate as a lender in the FNMA Delegated Underwriting and Servicing program. FNMA delegates responsibility for originating, underwriting, and servicing mortgages, and we assume a limited portion of the risk of loss during the remaining term on each commercial mortgage loan that we sell to FNMA. We maintain a reserve for such potential losses in an amount that we believe approximates the fair value of our liability. At June 30, 2016, the outstanding commercial mortgage loans in this program had a weighted-average remaining term of 7.6 years, and the unpaid

principal balance outstanding of loans sold by us as a participant was $6.7 billion. The maximum potential amount of undiscounted future payments that we could be required to make under this program, as shown in the preceding table, is equal to approximately 30% of the principal balance of loans outstanding at June 30, 2016. If we are required to make a payment, we would have an interest in the collateral underlying the related commercial mortgage loan; any loss we incur could be offset by the amount of any recovery from the collateral.

Return guarantee agreement with LIHTC investors. 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 low-income housing tax credits under Section 42 of the Internal Revenue Code. In certain partnerships, investors paid 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 15-year compliance period. Typically, KAHC fulfills these guaranteed returns by distributing tax credits and deductions associated with the specific properties. If KAHC defaults on its obligation to provide the guaranteed return, KeyBank is obligated to make any necessary payments to investors. No recourse or collateral is available to offset our guarantee obligation other than the underlying income streams from the properties and the residual value of the operating partnership interests.

As shown in the previous table, KAHC maintained a reserve in the amount of $3 million at June 30, 2016, which is 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.

These guarantees have expiration dates that extend through 2018, but KAHC has not formed any new partnerships under this program since October 2003. Additional information regarding these partnerships is included in Note 9 (“Variable Interest Entities”).

Written put options. In the ordinary course of business, we “write” put options for clients that wish to mitigate their exposure to changes in interest rates and commodity prices. At June 30, 2016, our written put options had an average life of 2 years. These instruments are considered to be guarantees, as we are required to make payments to the counterparty (the client) based on changes in an underlying variable that is related to an asset, a liability, or an equity security that the client holds. We are obligated to pay the client if the applicable benchmark interest rate or commodity price is above or below a specified level (known as the “strike rate”). These written put options are accounted for as derivatives at fair value, as further discussed in Note 7 (“Derivatives and Hedging Activities”). We mitigate our potential future payment obligations by entering into offsetting positions with third parties.

Written put options where the counterparty is a broker-dealer or bank are accounted for as derivatives at fair value but are not considered guarantees since these counterparties typically do not hold the underlying instruments. In addition, we are a purchaser and seller of credit derivatives, which are further discussed in Note 7.

Default guarantees. Some lines of business participate in guarantees that obligate us to perform if the debtor (typically a client) fails to satisfy all of its payment obligations to third parties. We generally undertake these guarantees for one of two possible reasons: (i) either the risk profile of the debtor should provide an investment return, or (ii) we are supporting our underlying investment in the debtor. We do not hold collateral for the default guarantees. If we were required to make a payment under a guarantee, we would receive a pro rata share should the third party collect some or all of the amounts due from the debtor. At June 30, 2016, we had $1 million of default guarantees.

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 the applicable accounting guidance, and from other relationships.

Indemnifications provided in the ordinary course of business. We provide certain indemnifications, primarily through representations and warranties in contracts that we execute in the ordinary course of business in connection with loan and lease sales and other ongoing activities, as well as in connection with purchases and sales of businesses. We maintain reserves, when appropriate, with respect to liability that reasonably could arise as a result of these indemnities.

Intercompany guarantees. KeyCorp, KeyBank, and certain of our affiliates are parties to various guarantees that facilitate the ongoing business activities of other affiliates. These business activities encompass issuing debt, assuming certain lease and insurance obligations, purchasing or issuing investments and securities, and engaging in certain leasing transactions involving clients.

16. Accumulated Other Comprehensive Income

Our changes in AOCI for the three and six months ended June 30, 2016, and June 30, 2015, are as follows:


in millions	Unrealized gains (losses) on securities available for sale			Unrealized gains (losses) on derivative financial instruments			Foreign currency translation adjustment			Net pension and postretirement benefit costs			Total
Balance at December 31, 2015	$	(58	)	$	20		$	(2	)	$	(365	)	$	(405	)
Other comprehensive income before reclassification, net of income taxes		187			121			7			(2	)		313
Amounts reclassified from accumulated other comprehensive income, net of income taxes^(a)		—			(27	)		—			5			(22	)

Net current-period other comprehensive income, net of income taxes		187			94			7			3			291

Balance at June 30, 2016	$	129		$	114		$	5		$	(362	)	$	(114	)

Balance at March 31, 2016	$	70		$	78		$	3		$	(364	)	$	(213	)
Other comprehensive income before reclassification, net of income taxes		59			49			2			—			110
Amounts reclassified from accumulated other comprehensive income, net of income taxes^(a)		—			(13	)		—			2			(11	)

Net current-period other comprehensive income, net of income taxes		59			36			2			2			99

Balance at June 30, 2016	$	129		$	114		$	5		$	(362	)	$	(114	)

Balance at December 31, 2014	$	(4	)	$	(8	)	$	22		$	(366	)	$	(356	)
Other comprehensive income before reclassification, net of income taxes		3			42			(14	)		—			31
Amounts reclassified from accumulated other comprehensive income, net of income taxes^(a)		1			(27	)		1			5			(20	)

Net current-period other comprehensive income, net of income taxes		4			15			(13	)		5			11

Balance at June 30, 2015		—		$	7		$	9		$	(361	)	$	(345	)

Balance at March 31, 2015	$	51		$	24		$	9		$	(363	)	$	(279	)
Other comprehensive income before reclassification, net of income taxes		(52	)		(3	)		(1	)		—			(56	)
Amounts reclassified from accumulated other comprehensive income, net of income taxes^(a)		1			(14	)		1			2			(10	)

Net current-period other comprehensive income, net of income taxes		(51	)		(17	)		—			2			(66	)

Balance at June 30, 2015		—		$	7		$	9		$	(361	)	$	(345	)

(a)	See table below for details about these reclassifications.

Our reclassifications out of AOCI for the three and six months ended June 30, 2016, and June 30, 2015, are as follows:


Six months ended June 30, 2016 in millions	Amount Reclassified from Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Unrealized gains (losses) on derivative financial instruments
Interest rate	$	45		Interest income — Loans
Interest rate		(2	)	Interest expense — Long-term debt

		43		Income (loss) from continuing operations before income taxes
		16		Income taxes

	$	27		Income (loss) from continuing operations

Net pension and postretirement benefit costs
Amortization of losses	$	(8	)	Personnel expense
Amortization of unrecognized prior service credit		—		Personnel expense

		(8	)	Income (loss) from continuing operations before income taxes
		(3	)	Income taxes

	$	(5	)	Income (loss) from continuing operations


Three months ended June 30, 2016 in millions	Amount Reclassified from Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Unrealized gains (losses) on derivative financial instruments
Interest rate	$	22		Interest income — Loans
Interest rate		(1	)	Interest expense — Long-term debt

		21		Income (loss) from continuing operations before income taxes
		8		Income taxes

	$	13		Income (loss) from continuing operations

Net pension and postretirement benefit costs Amortization of losses	$	(4	)	Personnel expense

		(4	)	Income (loss) from continuing operations before income taxes
		(2	)	Income taxes

	$	(2	)	Income (loss) from continuing operations


Six months ended June 30, 2015 in millions	Amount Reclassified from Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Unrealized gains (losses) on available for sale securities
Realized losses	$	(1	)	Other income

		(1	)	Income (loss) from continuing operations before income taxes
		—		Income taxes

	$	(1	)	Income (loss) from continuing operations

Unrealized gains (losses) on derivative financial instruments
Interest rate	$	45		Interest income — Loans
Interest rate		(2	)	Interest expense — Long-term debt

		43		Income (loss) from continuing operations before income taxes
		16		Income taxes

	$	27		Income (loss) from continuing operations

Foreign currency translation adjustment
	$	(1	)	Corporate services income

		(1	)	Income (loss) from continuing operations before income taxes
		—		Income taxes

	$	(1	)	Income (loss) from continuing operations

Net pension and postretirement benefit costs
Amortization of losses	$	(9	)	Personnel expense
Amortization of prior service credit		1		Personnel expense

		(8	)	Income (loss) from continuing operations before income taxes
		(3	)	Income taxes

	$	(5	)	Income (loss) from continuing operations


Three months ended June 30, 2015 in millions	Amount Reclassified from Accumulated Other Comprehensive Income			Affected Line Item in the Statement Where Net Income is Presented
Unrealized gains (losses) on available for sale securities
Realized losses	$	(1	)	Other income

		(1	)	Income (loss) from continuing operations before income taxes
		—		Income taxes

	$	(1	)	Income (loss) from continuing operations

Unrealized gains (losses) on derivative financial instruments
Interest rate	$	23		Interest income — Loans
Interest rate		(1	)	Interest expense — Long term debt

		22		Income (loss) from continuing operations before income taxes
		8		Income taxes

	$	14		Income (loss) from continuing operations

Foreign currency translation adjustment
	$	(1	)	Corporate services income

		(1	)	Income (loss) from continuing operations before income taxes
		—		Income taxes

	$	(1	)	Income (loss) from continuing operations

Net pension and postretirement benefit costs
Amortization of losses	$	(5	)	Personnel expense
Amortization of prior service credit		1		Personnel expense

		(4	)	Income (loss) from continuing operations before income taxes
		(2	)	Income taxes

	$	(2	)	Income (loss) from continuing operations

17. Shareholders’ Equity

Comprehensive Capital Plan

As previously reported and as authorized by the Board and pursuant to our 2015 capital plan (which was effective through the second quarter of 2016) submitted to and not objected to by the Federal Reserve, we had authority to repurchase up to $725 million of our common shares, which include repurchases to offset issuances of common shares under our employee compensation plans. Common share repurchases were suspended in the fourth quarter of 2015 in connection with the announcement of our acquisition of First Niagara.

On June 29, 2016, the Federal Reserve announced that it did not object to our 2016 capital plan submitted as part of the annual CCAR process. Share repurchases of up to $350 million were included in the 2016 capital plan, which is effective through the second quarter of 2017. We anticipate repurchasing common shares in the third quarter of 2016 plan following the completion of the acquisition of First Niagara.

Our 2015 capital plan proposed an increase in our quarterly common share dividend from $.075 to $.085 per share. This dividend increase was approved in May 2016 by our Board, who subsequently declared a quarterly dividend of $.085 per common share for the second quarter of 2016. Our 2016 capital plan proposed an increase in our quarterly common share dividend, up to $.095 per share, which will be considered by the Board for the second quarter of 2017.

Preferred Stock

We made a quarterly dividend payment of $1.9375 per share, or $5.6 million, on our Series A Preferred Stock during the second quarter of 2016.

First Niagara Merger

As disclosed in Note 11 (“Acquisitions and Discontinued Operations”), on August 1, 2016, First Niagara merged with and into KeyCorp, with KeyCorp as the surviving entity. At the effective time of the merger, each share of First Niagara common stock is converted into the right to receive (i) 0.680 of a share of KeyCorp common stock and (ii) $2.30 in cash. First Niagara equity awards outstanding immediately prior to the effective time of the merger are converted into equity awards for KeyCorp common stock as provided in the Agreement. Each share of First Niagara’s Fixed-to-Floating Rate Perpetual Non-Cumulative Preferred Stock, Series B, is converted into a share of a newly created series of preferred stock of KeyCorp having substantially the same terms as First Niagara’s preferred stock.

18. Line of Business Results

The specific lines of business that constitute each of the major business segments (operating segments) are described below.

Key Community Bank

Key Community Bank serves individuals and small to mid-sized businesses through its 12-state branch network.

Individuals are provided branch-based deposit and investment products, personal finance services, and loans, including residential mortgages, home equity, credit card, and various types of installment loans. In addition, financial, estate and retirement planning, asset management services, and Delaware Trust capabilities are offered to assist high-net-worth clients with their banking, trust, portfolio management, insurance, charitable giving, and related needs.

Small businesses are provided deposit, investment and credit products, and business advisory services. Mid-sized businesses are provided products and services, some of which are delivered by Key Corporate Bank, that include commercial lending, cash management, equipment leasing, investment and employee benefit programs, succession planning, access to capital markets, derivatives, and foreign exchange.

Key Corporate Bank

Key Corporate Bank is a full-service corporate and investment bank focused principally on serving the needs of middle market clients in seven industry sectors: consumer, energy, healthcare, industrial, public sector, real estate, and technology. Key Corporate Bank delivers a broad suite of banking and capital markets products to its clients, including syndicated finance, debt and equity capital markets, commercial payments, equipment finance, commercial mortgage banking, derivatives, foreign exchange, financial advisory, and public finance. Key Corporate Bank is also a significant servicer of commercial mortgage loans and a significant special servicer of CMBS. Key Corporate Bank delivers many of its product capabilities to clients of Key Community Bank.

Other Segments

Other Segments consists of Corporate Treasury, Principal Investing, and various exit portfolios.

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 including merger-related expense.

The table on the following pages shows selected financial data for our major business segments for the three- and six- month periods ended June 30, 2016, and June 30, 2015.

The information was derived from the internal financial reporting system that we use to monitor and manage our financial performance. GAAP guides financial accounting, but there is no authoritative guidance for “management accounting” — the way we use our judgment and experience to make reporting decisions. Consequently, the line of business results we report may not be comparable to line of business results presented by other companies.

The selected financial data is 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. In accordance with our 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.

•

Indirect expenses, such as computer servicing costs and corporate overhead, are allocated based on assumptions regarding the extent that each line of business actually uses the services.

•

The consolidated provision for credit losses is allocated among the lines of business primarily based on their actual net loan charge-offs, adjusted periodically for loan growth and changes in risk profile. The amount of the consolidated provision is based on the methodology that we use to estimate our consolidated ALLL. This methodology is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses” beginning on page 122 of our 2015 Form 10-K.

•

Income taxes are allocated based on the statutory federal income tax rate of 35% and a blended state income tax rate (net of the federal income tax benefit) of 2.2%.

•

Capital is assigned to each line of business based on economic equity.

Developing and applying the methodologies that we use to allocate items among our lines of business is a dynamic process. Accordingly, financial results may be revised periodically to reflect enhanced alignment of expense base allocation drivers, changes in the risk profile of a particular business, or changes in our organizational structure.


Three months ended June 30,	Key Community Bank						Key Corporate Bank
dollars in millions	2016			2015			2016			2015
SUMMARY OF OPERATIONS
Net interest income (TE)	$	391		$	362		$	222		$	228
Noninterest income		207			198			230			250

Total revenue (TE)^(a)		598			560			452			478
Provision for credit losses		25			3			30			41
Depreciation and amortization expense		12			14			13			11
Other noninterest expense		432			433			246			245

Income (loss) from continuing operations before income taxes (TE)		129			110			163			181
Allocated income taxes and TE adjustments		48			41			29			50

Income (loss) from continuing operations		81			69			134			131
Income (loss) from discontinued operations, net of taxes		—			—			—			—

Net income (loss)		81			69			134			131
Less: Net income (loss) attributable to noncontrolling interests		—			—			(1	)		—

Net income (loss) attributable to Key	$	81		$	69		$	135		$	131

AVERAGE BALANCES^(b)
Loans and leases	$	30,936		$	30,707		$	28,607		$	25,298
Total assets^(a)		32,963			32,809			33,909			31,173
Deposits		53,794			50,765			19,129			19,709

OTHER FINANCIAL DATA
Net loan charge-offs^(b)	$	17		$	20		$	27		$	12
Return on average allocated equity^(b)		11.99	%		10.34	%		26.23	%		29.24	%
Return on average allocated equity		11.99			10.34			26.24			29.24
Average full-time equivalent employees^(c)		7,331			7,574			2,138			2,058

Six months ended June 30,	Key Community Bank						Key Corporate Bank
dollars in millions	2016			2015			2016			2015
SUMMARY OF OPERATIONS
Net interest income (TE)	$	790		$	720		$	440		$	442
Noninterest income		403			388			437			438

Total revenue (TE) ^(a)		1,193			1,108			877			880
Provision for credit losses		66			32			73			47
Depreciation and amortization expense		25			29			26			20
Other noninterest expense		856			855			469			455

Income (loss) from continuing operations before income taxes (TE)		246			192			309			358
Allocated income taxes and TE adjustments		92			72			57			99

Income (loss) from continuing operations		154			120			252			259
Income (loss) from discontinued operations, net of taxes		—			—			—			—

Net income (loss)		154			120			252			259
Less: Net income (loss) attributable to noncontrolling interests		—			—			(2	)		1

Net income (loss) attributable to Key	$	154		$	120		$	254		$	258

AVERAGE BALANCES ^(b)
Loans and leases	$	30,863		$	30,684		$	28,164		$	25,012
Total assets ^(a)		32,910			32,789			33,661			30,709
Deposits		53,299			50,591			18,602			19,142

OTHER FINANCIAL DATA
Net loan charge-offs ^(b)	$	40		$	49		$	45		$	8
Return on average allocated equity ^(b)		11.47	%		8.94	%		24.80	%		28.45	%
Return on average allocated equity		11.47			8.94			24.78			28.45
Average full-time equivalent employees ^(c)		7,353			7,608			2,132			2,057

(a)

Substantially all revenue generated by our major business segments is derived from clients that reside in the United States. Substantially all long-lived assets, including premises and equipment, capitalized software, and goodwill held by our major business segments, are located in the United States.

(b)	From continuing operations.

(c)	The number of average full-time equivalent employees was not adjusted for discontinued operations.


Other Segments						Total Segments						Reconciling Items						Key
2016			2015			2016			2015			2016			2015			2016			2015
$	(11	)	$	(1	)	$	602		$	589		$	3		$	2		$	605		$	591
	42			44			479			492			(6	)		(4	)		473			488

	31			43			1,081			1,081			(3	)		(2	)		1,078			1,079
	(3	)		(2	)		52			42			—			(1	)		52			41
	1			2			26			27			36			38			62			65
	10			10			688			688			1			(42	)		689			646

	23			33			315			324			(40	)		3			275			327
	(2	)		1			75			92			2			(1	)		77			91

	25			32			240			232			(42	)		4			198			236
	—			—			—			—			3			3			3			3

	25			32			240			232			(39	)		7			201			239
	1			1			—			1			(1	)		—			(1	)		1

$	24		$	31		$	240		$	231		$	(38	)	$	7		$	202		$	238


$	1,519		$	1,903		$	61,062		$	57,908		$	86		$	70		$	61,148		$	57,978
	30,121			27,025			96,993			91,007			420			651			97,413			91,658
	972			442			73,895			70,916			9			(78	)		73,904			70,838


	—		$	3		$	44		$	35			(1	)	$	1		$	43		$	36
	57.46	%		56.52	%		19.48	%		19.74	%		(2.66	)%		.27	%		7.18	%		8.90	%
	56.12			55.51			19.47			19.72			(2.47	)		.48			7.29			9.01
	4			14			9,473			9,646			3,946			3,809			13,419			13,455

Other Segments						Total Segments						Reconciling Items						Key
2016			2015			2016			2015			2016			2015			2016			2015

	(20	)	$	3		$	1,210		$	1,165		$	7		$	3		$	1,217		$	1,168
$	72			106			912			932			(8	)		(7	)		904			925

	52			109			2,122			2,097			(1	)		(4	)		2,121			2,093
	2			(4	)		141			75			—			1			141			76
	3			5			54			54			72			75			126			129
	19			22			1,344			1,332			(16	)		(81	)		1,328			1,251

	28			86			583			636			(57	)		1			526			637
	(11	)		10			138			181			3			(10	)		141			171

	39			76			445			455			(60	)		11			385			466
	—			—			—			—			4			8			4			8

	39			76			445			455			(56	)		19			389			474
	1			2			(1	)		3			—			—			(1	)		3

$	38		$	74		$	446		$	452		$	(56	)	$	19		$	390		$	471


$	1,561		$	1,973		$	60,588		$	57,669		$	64		$	77		$	60,652		$	57,746
	28,925			26,486			95,496			89,984			449			664			95,945			90,648
	864			454			72,765			70,187			(14	)		(80	)		72,751			70,107


$	5		$	7		$	90		$	64		$	(1	)		—		$	89		$	64
	43.92	%		66.03	%		18.18	%		19.14	%		(1.97	)%		.38	%		7.02	%		8.82	%
	42.69			64.88			18.16			19.12			(1.84	)		.66			7.09			8.97
	6			15			9,491			9,680			3,920			3,832			13,411			13,512

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of KeyCorp

We have reviewed the consolidated balance sheets of KeyCorp as of June 30, 2016 and 2015, and the related consolidated statements of income and comprehensive income for the six-month periods ended June 30, 2016 and 2015, and the consolidated statements of changes in equity and cash flows for the six-month periods ended June 30, 2016 and 2015. These financial statements are the responsibility of KeyCorp’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 (United States), 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 consolidated 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 KeyCorp as of December 31, 2015, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for the year then ended (not presented herein) and we expressed an unqualified opinion on those consolidated financial statements in our report dated February 24, 2016. In our opinion, the accompanying consolidated balance sheet of KeyCorp as of December 31, 2015, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

Cleveland, Ohio

August 5, 2016

Ernst & Young LLP

Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations

Introduction

This section reviews the financial condition and results of operations of KeyCorp and its subsidiaries for the quarterly periods ended June 30, 2016, and June 30, 2015. 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 in this report. The page locations of specific sections and notes that we refer to are presented in the table of contents.

References to our “2015 Form 10-K” refer to our Form 10-K for the year ended December 31, 2015, which has been filed with the SEC and is available on its website (www.sec.gov) and on our website (www.key.com/ir).

Terminology

Throughout this discussion, references to “Key,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of KeyCorp and its subsidiaries. “KeyCorp” refers solely to the parent holding company, and “KeyBank” refers to KeyCorp’s subsidiary bank, KeyBank National Association.

We want to explain some industry-specific terms at the outset so you can better understand the discussion that follows.

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We use the phrase continuing operations in this document to mean all of our businesses other than the education lending business and Austin. The education lending business and Austin have been accounted for as discontinued operations since 2009.

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Our exit loan portfolios are separate from our discontinued operations. These portfolios, which are in a run-off mode, stem from product lines we decided to cease because they no longer fit with our corporate strategy. These exit loan portfolios are included in Other Segments.

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We engage in capital markets activities primarily through business conducted by our Key Corporate Bank segment. These activities encompass a variety of products and services. Among other things, we trade securities as a dealer, enter into derivative contracts (both to accommodate clients’ financing needs and to mitigate certain risks), and conduct transactions in foreign currencies (both to accommodate clients’ needs and to benefit from fluctuations in exchange rates).

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For regulatory purposes, capital is divided into two classes. Federal regulations currently prescribe that at least one-half of a bank or BHC’s total risk-based capital must qualify as Tier 1 capital. 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. As described under the heading “Regulatory capital and liquidity – Capital planning and stress testing” in the section entitled “Supervision and Regulation” that begins on page 9 of our 2015 Form 10-K, the regulators are required to conduct a supervisory capital assessment of all BHCs with assets of at least $50 billion, including KeyCorp. As part of this capital adequacy review, banking regulators evaluate a component of Tier 1 capital, known as Common Equity Tier 1, under the Regulatory Capital Rules. The “Capital” section of this report under the heading “Capital adequacy” provides more information on total capital, Tier 1 capital, and the Regulatory Capital Rules, including Common Equity Tier 1, and describes how these measures are calculated.

Additionally, a comprehensive list of the acronyms and abbreviations used throughout this discussion is included in Note 1 (“Basis of Presentation and Accounting Policies”).

Selected financial data

Our financial performance for each of the last five quarters is summarized in Figure 1.

Figure 1. Selected Financial Data


	2016						2015									Six months ended June 30,
dollars in millions, except per share amounts	Second			First			Fourth			Third			Second			2016			2015
FOR THE PERIOD
Interest income	$	684		$	683		$	673		$	661		$	652		$	1,367		$	1,288
Interest expense		87			79			71			70			68			166			133
Net interest income		597			604			602			591			584			1,201			1,155
Provision for credit losses		52			89			45			45			41			141			76
Noninterest income		473			431			485			470			488			904			925
Noninterest expense		751			703			736			724			711			1,454			1,380
Income (loss) from continuing operations before income taxes		267			243			306			292			320			510			624
Income (loss) from continuing operations attributable to Key		199			187			230			222			235			386			463
Income (loss) from discontinued operations, net of taxes ^(a)		3			1			(4	)		(3	)		3			4			8
Net income (loss) attributable to Key		202			188			226			219			238			390			471
Income (loss) from continuing operations attributable to Key common shareholders		193			182			224			216			230			375			452
Income (loss) from discontinued operations, net of taxes ^(a)		3			1			(4	)		(3	)		3			4			8
Net income (loss) attributable to Key common shareholders		196			183			220			213			233			379			460

PER COMMON SHARE
Income (loss) from continuing operations attributable to Key common shareholders	$	.23		$	.22		$	.27		$	.26		$	.27		$	.45		$	.53
Income (loss) from discontinued operations, net of taxes ^(a)		—			—			(.01	)		—			—			—			.01
Net income (loss) attributable to Key common shareholders ^(b)		.23			.22			.27			.26			.28			.45			.54
Income (loss) from continuing operations attributable to Key common shareholders — assuming dilution	$	.23		$	.22		$	.27		$	.26		$	.27		$	.44		$	.52
Income (loss) from discontinued operations, net of taxes — assuming dilution ^(a)		—			—			(.01	)		—			—			—			.01
Net income (loss) attributable to Key common shareholders — assuming dilution ^(b)		.23			.22			.26			.25			.27			.45			.53
Cash dividends paid		.085			.075			.075			.075			.075			.16			.14
Book value at period end		13.08			12.79			12.51			12.47			12.21			13.08			12.21
Tangible book value at period end		11.81			11.52			11.22			11.17			10.92			11.81			10.92
Market price:
High		13.08			13.37			14.01			15.46			15.70			13.37			15.70
Low		10.21			9.88			12.37			12.65			13.90			9.88			12.04
Close		11.05			11.04			13.19			13.01			15.02			11.05			15.02
Weighted-average common shares outstanding (000)		831,899			827,381			828,206			831,430			839,454			829,640			843,992
Weighted-average common shares and potential common shares outstanding (000) ^(c)		838,496			835,060			835,939			838,880			846,312			836,778			851,687

AT PERIOD END
Loans	$	62,098		$	60,438		$	59,876		$	60,085		$	58,264		$	62,098		$	58,264
Earning assets		90,065			87,273			83,780			83,779			82,964			90,065			82,964
Total assets		101,150			98,402			95,131			95,420			94,604			101,150			94,604
Deposits		75,325			73,382			71,046			71,073			70,669			75,325			70,669
Long-term debt		11,388			10,760			10,184			10,308			10,265			11,388			10,265
Key common shareholders’ equity		11,023			10,776			10,456			10,415			10,300			11,023			10,300
Key shareholders’ equity		11,313			11,066			10,746			10,705			10,590			11,313			10,590

PERFORMANCE RATIOS — FROM CONTINUING OPERATIONS
Return on average total assets		.82	%		.80	%		.97	%		.95	%		1.03	%		.81	%		1.03	%
Return on average common equity		7.15			6.86			8.51			8.30			8.96			7.01			8.86
Return on average tangible common equity ^(d)		7.94			7.64			9.50			9.27			10.01			7.79			9.91
Net interest margin (TE)		2.76			2.89			2.87			2.87			2.88			2.83			2.89
Cash efficiency ratio ^(d)		69.0			66.6			66.4			66.9			65.1			67.8			65.1

PERFORMANCE RATIOS — FROM CONSOLIDATED OPERATIONS
Return on average total assets		.82	%		.79	%		.93	%		.92	%		1.02	%		.80	%		1.02	%
Return on average common equity		7.26			6.90			8.36			8.19			9.07			7.08			9.01
Return on average tangible common equity ^(d)		8.06			7.68			9.33			9.14			10.14			7.87			10.08
Net interest margin (TE)		2.74			2.83			2.84			2.84			2.85			2.80			2.86
Loan-to-deposit ^(e)		85.3			85.7			87.8			89.3			87.3			85.3			87.3

CAPITAL RATIOS AT PERIOD END
Key shareholders’ equity to assets		11.18	%		11.25	%		11.30	%		11.22	%		11.19	%		11.18	%		11.19	%
Key common shareholders’ equity to assets		10.90			10.95			10.99			10.91			10.89			10.90			10.89
Tangible common equity to tangible assets ^(d)		9.95			9.97			9.98			9.90			9.86			9.95			9.86
Common Equity Tier 1 ^(d)		11.10			11.07			10.94			10.47			10.71			11.10			10.71
Tier 1 risk-based capital		11.41			11.38			11.35			10.87			11.11			11.41			11.11
Total risk-based capital		13.63			13.12			12.97			12.47			12.66			13.63			12.66
Leverage		10.59			10.73			10.72			10.68			10.74			10.59			10.74

TRUST AND BROKERAGE ASSETS
Assets under management	$	34,535		$	34,107		$	33,983		$	35,158		$	38,399		$	34,535		$	38,399
Nonmanaged and brokerage assets		52,102			49,474			47,681			46,796			48,789			52,102			48,789

OTHER DATA
Average full-time-equivalent employees		13,419			13,403			13,359			13,555			13,455			13,411			13,512
Branches		949			961			966			972			989			949			989

(a)

(b)	EPS may not foot due to rounding.

(c)	Assumes conversion of common share options and other stock awards and/or convertible preferred stock, as applicable.

(d)

See Figure 7 entitled “GAAP to Non-GAAP Reconciliations,” which presents the computations of certain financial measures related to “tangible common equity,” “Common Equity Tier 1” and “cash efficiency.” The table reconciles the GAAP performance measures to the corresponding non-GAAP measures, which provides a basis for period-to-period comparisons.

(e)	Represents period-end consolidated total loans and loans held for sale divided by period-end consolidated total deposits (excluding deposits in foreign office).

Forward-looking statements

From time to time, we have made or will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements do not relate strictly to historical or current facts. Forward-looking statements usually can be identified by the use of words such as “goal,” “objective,” “plan,” “expect,” “assume,” “anticipate,” “intend,” “project,” “believe,” “estimate,” or other words of similar meaning. Forward-looking statements provide our current expectations or forecasts of future events, circumstances, results or aspirations. Our disclosures in this report contain forward-looking statements. We may also make forward-looking statements in other documents filed with or furnished to the SEC. In addition, we may make forward-looking statements orally to analysts, investors, representatives of the media, and others.

Forward-looking statements, by their nature, are subject to assumptions, risks, and uncertainties, many of which are outside of our control. Our actual results may differ materially from those set forth in our forward-looking statements. There is no assurance that any list of risks and uncertainties or risk factors is complete. Factors that could cause our actual results to differ from those described in forward-looking statements include, but are not limited to:

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deterioration of commercial real estate market fundamentals;

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defaults by our loan counterparties or clients;

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adverse changes in credit quality trends;

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declining asset prices;

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our concentrated credit exposure in commercial, financial and agricultural loans;

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the extensive and increasing regulation of the U.S. financial services industry;

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changes in accounting policies, standards, and interpretations;

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breaches of security or failures of our technology systems due to technological or other factors and cybersecurity threats;

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operational or risk management failures by us or critical third parties;

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negative outcomes from claims or litigation;

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the occurrence of natural or man-made disasters, conflicts, or terrorist attacks, or other adverse external events;

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increasing capital and liquidity standards under applicable regulatory rules;

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unanticipated changes in our liquidity position, including but not limited to, changes in our access to or the cost of funding, our ability to enter the financial markets and to secure alternative funding sources;

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our ability to receive dividends from our subsidiary, KeyBank;

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downgrades in our credit ratings or those of KeyBank;

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a reversal of the U.S. economic recovery due to financial, political, or other shocks;

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our ability to anticipate interest rate changes and manage interest rate risk;

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deterioration of economic conditions in the geographic regions where we operate;

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the soundness of other financial institutions;

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our ability to attract and retain talented executives and employees and to manage our reputational risks;

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our ability to timely and effectively implement our strategic initiatives;

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increased competitive pressure due to industry consolidation;

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unanticipated adverse effects of strategic partnerships or acquisitions and dispositions of assets or businesses;

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our ability to realize the anticipated benefits of the First Niagara merger; and

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our ability to develop and effectively use the quantitative models we rely upon in our business planning.

Any forward-looking statements made by us or on our behalf speak only as of the date they are made, and we do not undertake any obligation to update any forward-looking statement to reflect the impact of subsequent events or circumstances. Before making an investment decision, you should carefully consider all risks and uncertainties disclosed in our SEC filings, including this report on Form 10-Q and our subsequent reports on Forms 8-K, 10-Q, and 10-K, and our registration statements under the Securities Act of 1933, as amended, all of which are or will upon filing be accessible on the SEC’s website at www.sec.gov and on our website at www.key.com/ir.

Economic overview

The economy rebounded in the second quarter of 2016, with the Federal Reserve Bank of Atlanta estimating real GDP of 2.4%, up from just 1.1% in the first quarter. Second quarter GDP growth was supported by a rebound in consumption even as nonresidential and residential investment dragged on growth. Meanwhile, average job gains fell for the third straight quarter as a result of a disappointing May employment report. Housing market data improved further, with slow advances in residential construction and modest improvement year-over-year in sales of existing homes. Geopolitical tensions, slowing global growth and uncertainty around prospective Federal Reserve actions prevented the economy from accelerating further during the first half of the year.

In the second quarter of 2016, real spending advanced in April and May, rebounding from weak spending dating back to the end of last year, with improvements in both durable and nondurable goods expenditures. Retail sales have shown steady improvement with sales excluding automobiles rising 3.2% year-over-year in June, up from 2.1% in March 2016. Consumer confidence rose modestly from the first quarter, with the Conference Board measure ending the second quarter of 2016 at 98.0, up 1.9 points from March. Inflation remains well below the Federal Reserve target, with the personal consumption expenditure index up just .9% year-over-year as of May 2016.

In the labor market, average monthly job gains declined to 147,000 during the second quarter of 2016, compared to the solid first quarter 2016 average of 196,000, marking the third straight quarter of decline in the monthly average. The second quarter average was adversely impacted by a weak May report, with gains of only 11,000 for the month. Gains continue to be driven by the services sectors, while the goods-producing sectors have reported weakness since the end of last year. The unemployment rate rose to 4.9% in June of 2016, up 20 basis points from May, but down 10 basis points from the end of the first quarter, driven in part by a declining labor force and a lower participation rate.

The housing market improved modestly in the second quarter, with most metrics above year-ago levels. Existing home sales ended the quarter at 5.6 million units, compared to 5.4 million in March and slightly above year-ago levels. New Home Sales rebounded, ending the second quarter of 2016 10% higher than March and up 26% year-over-year increase. Housing starts have fallen modestly since the same period last year, totaling a seasonally adjusted annual rate of 1.19 million in June 2016, down 2% year-over-year and up 7% since the end of the first quarter. Housing permits rebounded from the start of the year, increasing 7% from March of 2016, but remain 14% below year-ago levels in June 2016. Home price appreciation is moderating, with May 2016 home prices up 5.9% year-over-year, down slightly from 6.7% from March 2016.

The Federal Reserve remained accommodative in the second quarter of 2016, continuing to reinvest principal payments to ease financial conditions. Forward guidance is somewhat unclear as to when the Federal Open Market Committee (FOMC) will again raise the federal funds target rate, as global economic conditions and inflation measures remain concerns. This, along with market uncertainty related to the United Kingdom leaving the European Union, has pushed interest rates lower. The yield on the 10-year U.S. Treasury dropped 29 basis points in the second quarter of 2016 to 1.49%.

Long-term financial goals

Our long-term financial goals are as follows:

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Improve balance sheet efficiency by targeting a loan-to-deposit ratio range of 90% to 100%;

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Maintain a moderate risk profile by targeting a net loan charge-offs to average loans ratio and provision for credit losses to average loans ratio in the range of .40% to .60%;

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Grow high quality, diverse revenue streams by targeting a net interest margin in the range of 3.00% to 3.25% and a ratio of noninterest income to total revenue of greater than 40%;

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Generate positive operating leverage and target a cash efficiency ratio excluding merger-related expense of less than 60%; and

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Maintain disciplined capital management and target a return on average assets excluding merger-related expense in the range of 1.00% to 1.25%.

Figure 2 shows the evaluation of our long-term financial goals for the six months ended June 30, 2016.

Figure 2. Evaluation of Our Long-Term Financial Goals


KEY Business Model	Key Metrics ^(a)	2Q16	YTD 2016			Targets
Balance sheet efficiency	Loan-to-deposit ratio ^(b)	85%		85	%		90 - 100	%

Moderate risk profile	Net loan charge-offs to average loans	.28%		.30	%		.40 - .60	%
Moderate risk profile	Provision for credit losses to average loans	.34%		.47	%		.40 - .60	%

High quality, diverse revenue streams	Net interest margin	2.76%		2.83	%		3.00 - 3.25	%
High quality, diverse revenue streams	Noninterest income to total revenue	44%		43	%		> 40	%

Positive operating leverage	Cash efficiency ratio^(c)	69.0%		67.8	%		< 60	%
Positive operating leverage	Cash efficiency ratio excluding merger-related expense^(c)	64.8%		64.6	%		< 60	%

Financial Returns	Return on average assets	.82%		.81	%		1.00 - 1.25	%
Financial Returns	Return on average assets excluding merger-related expense^(c)	.94%		.90	%		1.00 - 1.25	%

(a)	Calculated from continuing operations, unless otherwise noted.

(b)	Represents period-end consolidated total loans and loans held for sale divided by period-end consolidated total deposits (excluding deposits in foreign office).

(c)	Non-GAAP measure: see Figure 7 for reconciliation.

Strategic developments

Our actions and results during the first six months of 2016 supported our corporate strategy described in the “Introduction” section under the “Corporate strategy” heading on page 38 of our 2015 Form 10-K.

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We continue to focus on growing our businesses and remain committed to improving productivity and efficiency. During the first six months of 2016, we generated positive operating leverage excluding merger-related expense from the prior year, with revenue up 1.3% from 2015. Net interest income benefited from higher earning asset balances and an increase in earning asset yields, largely the result of our loan portfolio repricing to the higher short-term interest rates. Although noninterest income declined slightly from the prior year, we saw a benefit from increases in several of our core fee-based businesses where we continue to make investments: service charges on deposit accounts, corporate services income, and cards and payments income. Excluding merger-related expense of $69 million, noninterest expense increased $5 million from the prior year primarily due to slight increases across various nonpersonnel areas.

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Although asset quality measures were impacted during the first six months of 2016 by credit migration, primarily in our oil and gas portfolio, our net loan charge-offs were .30% of average loans, below our targeted range, and the provision for credit losses was .47% of average loans, within our targeted range.

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Capital management remains a priority for 2016. As previously reported, our existing share repurchase program under the 2015 capital plan (which was effective through the second quarter of 2015) was suspended in the fourth quarter of 2015 in connection with the announcement of our acquisition of First Niagara. On June 29, 2016, the Federal Reserve announced that it did not object to our 2016 capital plan. Share repurchases of up to $350 million were included in the 2016 capital plan, which is effective through the second quarter of 2017. We anticipate repurchasing common shares in the third quarter of 2016 following the completion of the acquisition of First Niagara.

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On August 1, 2016, First Niagara merged with and into KeyCorp, with KeyCorp as the surviving entity after receiving regulatory approval on July 12, 2016. The total consideration for the transaction was approximately $4.0 billion. Systems and client conversion is expected during the fourth quarter of 2016, subject to pending regulatory approval. On April 28, 2016, KeyCorp and First Niagara entered into an agreement with Northwest Bank, a wholly-owned subsidiary of Northwest Bancshares, Inc., to sell 18 branches in the Buffalo, New York market. The branches are being divested in connection with the merger between First Niagara and KeyCorp and pursuant to an agreement with the United States Department of Justice and commitments to the Board of Governors of the Federal Reserve System following a customary antitrust review in connection with the proposed merger.

Demographics

We have two major business segments: Key Community Bank and Key Corporate Bank.

Key Community Bank serves individuals and small to mid-sized businesses by offering a variety of deposit, investment, lending, credit card, and personalized wealth management products and business advisory services. These products and services are provided through our relationship managers and specialists working in our 12-state branch network, which is organized into eight internally defined geographic regions: Pacific, Rocky Mountains, Indiana, Western Ohio and Michigan, Eastern Ohio, Western New York, Eastern New York, and New England. In addition, some of these product capabilities are delivered by Key Corporate Bank to clients of Key Community Bank.

Figure 3 shows the geographic diversity of Key Community Bank’s average deposits, commercial loans, and home equity loans.

Figure 3. Key Community Bank Geographic Diversity


	Geographic Region
Three months ended June 30, 2016 dollars in millions	Pacific			Rocky Mountains			Indiana			West Ohio/ Michigan			East Ohio			Western New York			Eastern New York			New England			NonRegion^(a)			Total
Average deposits	$	12,754		$	5,416		$	2,400		$	4,717		$	10,083		$	5,185		$	8,107		$	3,041		$	2,091		$	53,794
Percent of total		23.7	%		10.1	%		4.5	%		8.8	%		18.7	%		9.6	%		15.1	%		5.6	%		3.9	%		100.0	%

Average commercial loans	$	3,421		$	1,927		$	893		$	1,236		$	2,369		$	684		$	1,916		$	824		$	3,178		$	16,448
Percent of total		20.8	%		11.7	%		5.4	%		7.5	%		14.4	%		4.2	%		11.7	%		5.0	%		19.3	%		100.0	%
Average home equity loans	$	3,131		$	1,495		$	482		$	803		$	1,227		$	823		$	1,235		$	642		$	70		$	9,908
Percent of total		31.6	%		15.1	%		4.8	%		8.1	%		12.4	%		8.3	%		12.5	%		6.5	%		.7	%		100.0	%

(a)	Represents average deposits, commercial loan products, and home equity loan products centrally managed outside of our eight Key Community Bank regions.

Key Corporate Bank delivers a broad suite of banking and capital markets products to its clients, including syndicated finance, debt and equity capital markets, commercial payments, equipment finance, commercial mortgage banking, derivatives, foreign exchange, financial advisory, and public finance. Key Corporate Bank is also a significant servicer of commercial mortgage loans and a significant special servicer of CMBS. Key Corporate Bank delivers many of its product capabilities to clients of Key Community Bank.

Further information regarding the products and services offered by our Key Community Bank and Key Corporate Bank segments is included in this report in Note 18 (“Line of Business Results”).

Supervision and regulation

Regulatory reform developments

On July 21, 2010, the Dodd-Frank Act became law. It was intended to address perceived deficiencies and gaps in the regulatory framework for financial services in the U.S., reduce the risks of bank failures, better equip the nation’s regulators to guard against or mitigate any future financial crises, and manage systemic risk through increased supervision of bank and nonbank SIFIs, such as KeyCorp and KeyBank. Further discussion concerning the Dodd-Frank Act, related regulatory developments, and the risks that they present to Key is available under the heading “Supervision and Regulation” in Item 1. Business and under the heading “II. Compliance Risk” in Item 1A. Risk Factors of our 2015 Form 10-K. Many proposed rules referenced in our prior reports remain pending. The following discussion provides a summary of recent regulatory developments relating to the Dodd-Frank Act or regulatory developments that relate to our results this quarter.

Regulatory capital rules

In October 2013, federal banking regulators published the final Basel III capital framework for U.S. banking organizations (the “Regulatory Capital Rules”). The Regulatory Capital Rules generally implement in the U.S. the Basel III capital framework published by the Basel Committee in December 2010 and revised in June 2011 and January 2014 (the “Basel III capital framework”). The Basel III capital framework and the U.S. implementation of the Basel III capital framework are discussed in more detail in Item 1. Business of our 2015 Form 10-K under the heading “Supervision and Regulation — Basel III capital and liquidity frameworks.”

While the Regulatory Capital Rules became effective on January 1, 2014, the mandatory compliance date for Key as a “standardized approach” banking organization was January 1, 2015, subject to transitional provisions extending to January 1, 2019.

New minimum capital and leverage ratio requirements

Under the Regulatory Capital Rules, “standardized approach” banking organizations, like KeyCorp, are required to meet the minimum capital and leverage ratios set forth in Figure 4 below. At June 30, 2016, Key had an estimated Common Equity Tier 1 Capital Ratio of 11.05% under the fully phased-in Regulatory Capital Rules. Also at June 30, 2016, based on the fully phased-in Regulatory Capital Rules, Key estimates that its capital and leverage ratios, after adjustment for market risk, would be as set forth in Figure 4.

Figure 4. Estimated Ratios vs. Minimum Capital Ratios Calculated Under the Fully Phased-In Regulatory Capital Rules


Ratios (including Capital conservation buffer)	Key June 30, 2016 Estimated			Minimum January 1, 2016			Phase-in Period	Minimum January 1, 2019
Common Equity Tier 1 ^(a)		11.05	%		4.5	%	None		4.5	%
Capital conservation buffer ^(b)					—		1/1/16-1/1/19		2.5
Common Equity Tier 1 + Capital conservation buffer					4.5		1/1/16-1/1/19		7.0
Tier 1 Capital		11.11			6.0		None		6.0
Tier 1 Capital + Capital conservation buffer					6.0		1/1/16-1/1/19		8.5
Total Capital		13.34			8.0		None		8.0
Total Capital + Capital conservation buffer					8.0		1/1/16-1/1/19		10.5
Leverage^(c)		10.36			4.0		None		4.0

(a)	See Figure 7 entitled “GAAP to Non-GAAP Reconciliations,” which presents the computation for estimated Common Equity Tier 1. The table reconciles the GAAP performance measure to the corresponding non-GAAP measure, which provides a basis for period-to-period comparisons.

(b)	Capital conservation buffer must consist of Common Equity Tier 1 capital. As a standardized approach banking organization, KeyCorp is not subject to the countercyclical capital buffer of up to 2.5% imposed upon an advanced approaches banking organization under the Regulatory Capital Rules.

(c)	As a standardized approach banking organization, KeyCorp is not subject to the 3% supplemental leverage ratio requirement, which becomes effective January 1, 2018.

Revised prompt corrective action capital category ratios

Under the Regulatory Capital Rules, the prompt corrective action capital category threshold ratios applicable to FDIC-insured depository institutions such as KeyBank were revised effective January 1, 2015. Figure 5 identifies the capital category threshold ratios for a “well capitalized” and an “adequately capitalized” institution under the Regulatory Capital Rules.

Figure 5. “Well Capitalized” and “Adequately Capitalized” Capital Category Ratios under Revised Prompt

Corrective Action Rules


Prompt Corrective Action	Capital Category
Ratio	Well Capitalized^(a)			Adequately Capitalized
Common Equity Tier 1 Risk-Based		6.5	%		4.5	%
Tier 1 Risk-Based		8.0			6.0
Total Risk-Based		10.0			8.0
Tier 1 Leverage		5.0			4.0

(a)	A “well capitalized” institution also must not be subject to any written agreement, order, or directive to meet and maintain a specific capital level for any capital measure.

(b)	As a standardized approach banking organization, KeyBank is not subject to the 3% supplemental leverage ratio requirement, which becomes effective January 1, 2018.

As of June 30, 2016, KeyBank meets all “well capitalized” capital adequacy requirements under the Regulatory Capital Rules.

Liquidity coverage ratio

In October 2014, the federal banking agencies published the final Basel III liquidity framework for U.S. banking organizations (the “Liquidity Coverage Rules”) that create a minimum LCR for certain internationally active bank and nonbank financial companies (excluding KeyCorp) and a modified version of the LCR (“Modified LCR”) for BHCs and other depository institution holding companies with over $50 billion in consolidated assets that are not internationally active (including KeyCorp).

Because KeyCorp is a Modified LCR BHC under the Liquidity Coverage Rules, Key is required to maintain its ratio of high-quality liquid assets to its total net cash outflow amount, determined by prescribed assumptions in a standardized hypothetical stress scenario over a 30-calendar day period. Implementation for Modified LCR banking organizations, like Key, began on January 1, 2016, with a minimum requirement of 90% coverage, reaching 100% coverage by January 1, 2017. For the second quarter of 2016, our Modified LCR was above 100%. In the future, we may change the composition of our investment portfolio, increase the size of the overall investment portfolio, and/or modify product offerings to enhance or optimize our liquidity position.

KeyBank will not be subject to the LCR or the Modified LCR under the Liquidity Coverage Rules unless the OCC affirmatively determines that application to KeyBank is appropriate in light of KeyBank’s asset size, level of complexity, risk profile, scope of operations, affiliation with foreign or domestic covered entities, or risk to the financial system.

Net stable funding ratio

As previously disclosed in the “Supervision and Regulation” section of Item 1. Business of our 2015 Form 10-K under the heading “Basel III capital and liquidity frameworks,” the Basel Committee finalized the Basel III net stable funding ratio (“NSFR”) in October 2014. The Basel Committee published final Basel III NSFR disclosure standards in June 2015. In April and May 2016, the federal banking regulators issued an NPR proposing to implement the final Basel III NSFR and the final Basel III NSFR disclosure standards. The proposal would create a minimum NSFR for certain internationally active banking organizations (excluding KeyCorp) and a modified version of the NSFR for BHCs and other depository institution holding companies with over $50 billion in consolidated assets that are not internationally active (including KeyCorp). The proposal would also require quarterly quantitative and qualitative public disclosures regarding the NSFR. The proposed NSFR requirement would apply beginning on January 1, 2018. The comment period for the NPR expires on August 5, 2016.

Common equity surcharge

In July 2015, the Federal Reserve adopted a final rule to implement the common equity surcharge on U.S. global systemically important banks (“G-SIBs”). The final rule was effective December 1, 2015, although the surcharge, which will be added to the capital conservation buffer under the Regulatory Capital Rules, will be phased in during the January 1, 2016, through January 1, 2019, period. Notably, this final rule applies to advanced approaches banking organizations, not “standardized approach” banking organizations like Key.

Deposit insurance and assessments

In March 2015, the FDIC approved a final rule to impose a surcharge, as required by the Dodd-Frank Act, on the quarterly deposit insurance assessments of insured depository institutions having total consolidated assets of at least $10 billion (like KeyBank). The surcharge is 4.5 cents per $100 of the institution’s assessment base (after making certain adjustments). The final rule became effective on July 1, 2016. If the DIF reserve ratio reaches 1.15% before that date, surcharges will begin July 1, 2016. If the reserve ratio has not reached 1.15% by that date, surcharges will begin the first quarter after the reserve ratio reaches 1.15%. The DIF reserve ratio was 1.13% at the end of the first quarter of 2016. It is expected that the FDIC will announce the DIF reserve ratio for the end of the second quarter of 2016 in late August or early September of 2016. Surcharges will continue through the quarter that the DIF reserve ratio reaches or exceeds 1.35%, but not later than December 31, 2018. If the reserve ratio does not reach 1.35% by December 31, 2018 (provided it is at least 1.15%), the FDIC will impose a shortfall assessment on March 31, 2019, on insured depository institutions with total consolidated assets of $10 billion or more (like KeyBank).

In February 2016, the FDIC issued an NPR proposing to impose recordkeeping requirements on insured depository institutions with two million or more deposit accounts (including KeyBank) in order to facilitate rapid payment of insured deposits to customers if the institutions were to fail. The proposal would require such insured depository institutions (i) to maintain complete and accurate data on each depositor’s ownership interest by right and capacity for all of the institution’s deposit accounts and (ii) to develop the capability to calculate the insured and uninsured amounts for each deposit owner within 24 hours of failure. The FDIC would conduct periodic testing of covered institutions’ compliance with these requirements and such institutions would be required to file a deposit insurance coverage summary report with the FDIC annually. Compliance would be required two years after the effective date of a final rule. After being extended, the comment period for the NPR expired on June 25, 2016.

Single counterparty credit limits

In March 2016, the Federal Reserve issued an NPR proposing to establish single counterparty credit limits for BHCs with total consolidated assets of $50 billion or more. This proposal would implement a provision in the Dodd-Frank Act and replaces proposals on this subject issued by the Federal Reserve in 2011 and 2012. Under the proposal, a covered BHC (including KeyCorp) would not be allowed to have an aggregate net credit exposure to any unaffiliated counterparty that exceeds 25% of the consolidated capital stock and surplus of the covered BHC. G-SIBs and certain other large BHCs (excluding KeyCorp) would be subject to stricter limits under the proposal. A covered BHC such as KeyCorp would be required to comply with the proposed limits and quarterly reporting to show such compliance starting two years after the effective date of a final rule. The comment period for the NPR expired on June 3, 2016.

ERISA fiduciary standard

On April 8, 2016, the Department of Labor published final rules and amendments to certain prohibited transaction exemptions regarding which service providers would be regarded as fiduciaries under ERISA for making investment advice recommendations to: 1) certain retirement plan fiduciaries, participants or beneficiaries and 2) owners or beneficiaries of individual retirement accounts and health savings accounts, among other retirement plans. In sum, the rules intend to place fiduciary obligations, rather than the lesser legal obligations that currently apply, on these service providers. The rules require any financial institution making recommendations for either the purchase or sale of investments in or rollover of the respective retirement plan be subject to certain fiduciary obligations under ERISA such as an impartial conduct standard and not selling certain investment products whose compensation may raise a conflict of interest for the advisor without entering into a contract providing certain disclosures and legal remedies to the customer. The requirement of impartial conduct is effective April 10, 2017, and the contract provisions must be in place by January 1, 2018. At present, we expect that this rule will affect our brokerage, trust and consumer deposit taking lines of business but are not able to determine how significant the new rules’ financial impact will be on our financial position.

Highlights of Our Performance

Financial performance

For the second quarter of 2016, we announced net income from continuing operations attributable to Key common shareholders of $193 million, or $.23 per common share. Our second quarter of 2016 results compare to net income from continuing operations attributable to Key common shareholders of $230 million, or $.27 per common share, for the second quarter of 2015.

Our taxable-equivalent net interest income was $605 million for the second quarter of 2016, and the net interest margin was 2.76%. These results compare to taxable-equivalent net interest income of $591 million and a net interest margin of 2.88% for the second quarter of 2015. The $14 million increase in net interest income reflects higher earning asset balances and an increase in earning asset yields, largely the result of our loan portfolio re-pricing to higher short-term interest rates. The benefit to net interest income from these items was partly offset by lower reinvestment yields in our securities and derivatives portfolios. The 12 basis point decline in the net interest margin reflects higher levels of liquidity, lower reinvestment yields in the securities and derivatives portfolios, and lower loan fees. Our Federal Reserve account averaged $5.6 billion during the second quarter of 2016, which increased $2.3 billion compared to the second quarter of 2015 and reduced the net interest margin by 7 basis points. For the full year of 2016, we expect low to mid-single-digit growth in net interest income compared to the prior year without the benefit of higher rates or mid-single digit growth with the benefit of higher interest rates.

Our noninterest income was $473 million for the second quarter of 2016, compared to $488 million for the year-ago quarter. The decrease from the prior year was largely attributable to lower investment banking and debt placement fees of $43 million, reflecting challenging market conditions, as well as $6 million of lower operating lease income and other leasing gains. These declines were offset by an increase of $17 million in other income primarily related to gains from certain real estate investments, along with continued growth in some of our core fee-based businesses, including corporate services and cards and payments. For the full year of 2016, we expect stable to up low single-digit growth in our noninterest income compared to the prior year.

Our noninterest expense was $751 million for the second quarter of 2016. Noninterest expense included $45 million of merger-related expense, primarily made up of $35 million in personnel expense related to technology development for systems conversions and fully-dedicated personnel for merger and integration efforts. The remaining $10 million of merger-related expense was nonpersonnel expense, largely recognized in business services and professional fees and marketing. There was no merger-related expense incurred in the second quarter of 2015. Excluding merger-related expense, noninterest expense was $5 million lower than the second quarter of last year. The decrease is primarily attributable to $16 million in lower personnel expense related to lower performance-based compensation, along with lower net occupancy expenses and business services and professional fees. These decreases were partially offset by an increase in other expense, reflecting the impact of certain real estate investments and other miscellaneous items, along with increased non-merger related marketing expense. For the full year of 2016, we expect noninterest expense excluding merger-related expense to be relatively stable with 2015.

Average loans were $61.1 billion for the second quarter of 2016, an increase of $3.2 billion compared to the second quarter of 2015. The loan growth primarily occurred in the commercial, financial and agricultural portfolio, which increased $3.6 billion and was spread across our commercial lines of business. Consumer loans declined by $504 million mostly due to paydowns on our home equity loan portfolio and continued run-off in our consumer exit portfolios. For the full year of 2016, we anticipate average loan growth in the mid-single digit range.

Average deposits, excluding deposits in foreign office, totaled $73.9 billion for the second quarter of 2016, an increase of $3.6 billion compared to the year-ago quarter. Interest-bearing deposits increased $4.9 billion driven by a $3.6 billion increase in NOW and money market deposit accounts and a $1.3 billion increase in certificates of deposit and other time deposits. The increase in average deposits from the year-ago quarter reflects core deposit growth in our retail banking franchise, growth in escrow deposits from the commercial mortgage servicing business, and commercial deposit inflows. These increases were partially offset by a $1.2 billion decline in noninterest-bearing deposits.

Our provision for credit losses was $52 million for the second quarter of 2016, compared to $41 million for the year-ago quarter. Our ALLL was $854 million, or 1.38% of total period-end loans at June 30, 2016, compared to 1.37% at June 30, 2015. For the remainder of 2016, we expect our ALLL as a percentage of period-end loans to remain relatively stable with the second quarter of 2016.

Net loan charge-offs for the second quarter of 2016 totaled $43 million, or .28% of average total loans, compared to .25% for the same period last year. We expect net loan charge-offs to average total loans to continue to be below our targeted range of .40% to .60% for the remainder of 2016.

At June 30, 2016, our nonperforming loans totaled $619 million and represented 1.00% of period-end portfolio loans, compared to $419 million, or .72% of period-end portfolio loans, at June 30, 2015. Nonperforming assets at June 30, 2016, totaled $637 million and represented 1.03% of period-end portfolio loans and OREO and other nonperforming assets, compared to $440 million, or .75% of period-end portfolio loans, at June 30, 2015. The increase in our nonperforming assets was primarily due to credit migration in the oil and gas portfolio.

Our capital ratios remain strong. Our tangible common equity and Tier 1 risk-based capital ratios at June 30, 2016, are 9.95% and 11.41%, respectively, compared to 9.86% and 11.11%, respectively, at June 30, 2015. In addition, our Common Equity Tier 1 ratio is 11.10% at June 30, 2016, compared to 10.71% at June 30, 2015. We continue to return capital to our shareholders through our quarterly common share dividend. In the second quarter of 2016, we paid a cash dividend of $.085 per common share, an increase from $.075 per common share, under our 2015 capital plan authorization.

Figure 6 shows our continuing and discontinued operating results for the current, past, and year-ago quarters. Our financial performance for each of the past five quarters is summarized in Figure 1.

Figure 6. Results of Operations


	Three months ended						Six months ended
in millions, except per share amounts	6-30-16		3-31-16		6-30-15		6-30-16		6-30-15
Summary of operations
Income (loss) from continuing operations attributable to Key	$	199	$	187	$	235	$	386	$	463
Income (loss) from discontinued operations, net of taxes ^(a)		3		1		3		4		8

Net income (loss) attributable to Key	$	202	$	188	$	238	$	390	$	471

Income (loss) from continuing operations attributable to Key	$	199	$	187	$	235	$	386	$	463
Less: Dividends on Series A Preferred Stock		6		5		5		11		11

Income (loss) from continuing operations attributable to Key common shareholders		193		182		230		375		452
Income (loss) from discontinued operations, net of taxes ^(a)		3		1		3		4		8

Net income (loss) attributable to Key common shareholders	$	196	$	183	$	233	$	379	$	460

Per common share — assuming dilution
Income (loss) from continuing operations attributable to Key common shareholders	$	.23	$	.22	$	.27	$	.44	$	.52
Income (loss) from discontinued operations, net of taxes ^(a)		—		—		—		—		.01

Net income (loss) attributable to Key common shareholders ^(b)	$	.23	$	.22	$	.27	$	.45	$	.53

(a)

(b)	EPS may not foot due to rounding.

Figure 7 presents certain non-GAAP financial measures related to “tangible common equity,” “return on tangible common equity,” “Common Equity Tier 1,” “pre-provision net revenue,” certain financial measures excluding merger-related expense, and “cash efficiency ratio.”

The tangible common equity ratio and the return on tangible common equity ratio have been a focus for some investors, and management believes these ratios may assist investors in analyzing Key’s capital position without regard to the effects of intangible assets and preferred stock. Traditionally, the banking regulators have assessed bank and BHC capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. The Federal Reserve focuses its assessment of capital adequacy on a component of Tier 1 capital known as Common Equity Tier 1. Because the Federal Reserve has long indicated that voting common shareholders’ equity (essentially Tier 1 risk-based capital less preferred stock and noncontrolling interests in subsidiaries) generally should be the dominant element in Tier 1 risk-based capital, this focus on Common Equity Tier 1 is consistent with existing capital adequacy categories. The Regulatory Capital Rules, described in more detail under the section “Supervision and regulation” in Item 2 of this report, also make Common Equity Tier 1 a priority. The Regulatory Capital Rules change the regulatory capital standards that apply to BHCs by, among other changes, phasing out the treatment of trust preferred securities and cumulative preferred securities as Tier 1 eligible capital. Starting in 2016, our trust preferred securities are only included in Tier 2 capital. Since analysts and banking regulators may assess our capital adequacy using tangible common equity and Common Equity Tier 1, we believe it is useful to enable investors to assess our capital adequacy on these same bases. Figure 7 also reconciles the GAAP performance measures to the corresponding non-GAAP measures.

Figure 7 also shows the computation for and reconciliation of pre-provision net revenue, which is not formally defined by GAAP. We believe that eliminating the effects of the provision for credit losses makes it easier to analyze our results by presenting them on a more comparable basis.

As disclosed in Note 11 (“Acquisitions and Discontinued Operations”), KeyCorp completed its purchase of First Niagara on August 1, 2016. The definitive agreement and plan of merger to acquire First Niagara was originally announced on October 30, 2015. As a result of this transaction, we’ve recognized merger-related expense. Figure 7 shows the computation of noninterest expense excluding merger-related expense and return on average assets from continuing operations excluding merger-related expense. We believe that eliminating the effects of the merger-related expense makes it easier to analyze our results by presenting them on a more comparable basis.

The cash efficiency ratio is a ratio of two non-GAAP performance measures. Accordingly, there is no directly comparable GAAP performance measure. The cash efficiency ratio excludes the impact of our intangible asset amortization from the calculation. We also disclosed the cash efficiency ratio excluding merger-related expense. We believe these ratios provide greater consistency and comparability between our results and those of our peer banks. Additionally, these ratios are used by analysts and investors as they develop earnings forecasts and peer bank analysis.

Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.

Figure 7. GAAP to Non-GAAP Reconciliations


	Three months ended
dollars in millions	6-30-16			3-31-16			12-31-15			9-30-15			6-30-15
Tangible common equity to tangible assets at period end
Key shareholders’ equity (GAAP)	$	11,313		$	11,066		$	10,746		$	10,705		$	10,590
Less: Intangible assets ^(a)		1,074			1,077			1,080			1,084			1,085
Series A Preferred Stock ^(b)		281			281			281			281			281

Tangible common equity (non-GAAP)	$	9,958		$	9,708		$	9,385		$	9,340		$	9,224

Total assets (GAAP)	$	101,150		$	98,402		$	95,131		$	95,420		$	94,604
Less: Intangible assets ^(a)		1,074			1,077			1,080			1,084			1,085

Tangible assets (non-GAAP)	$	100,076		$	97,325		$	94,051		$	94,336		$	93,519

Tangible common equity to tangible assets ratio (non-GAAP)		9.95	%		9.97	%		9.98	%		9.90	%		9.86	%
Common Equity Tier 1 at period end
Key shareholders’ equity (GAAP)	$	11,313		$	11,066		$	10,746		$	10,705			10,590
Less: Series A Preferred Stock ^(b)		281			281			281			281			281

Common Equity Tier 1 capital before adjustments and deductions		11,032			10,785			10,465			10,424			10,309
Less: Goodwill, net of deferred taxes		1,031			1,033			1,034			1,036			1,034
Intangible assets, net of deferred taxes		30			35			26			29			33
Deferred tax assets		1			1			1			1			1
Net unrealized gains (losses) on available-for-sale securities, net of deferred taxes		129			70			(58	)		54			—
Accumulated gains (losses) on cash flow hedges, net of deferred taxes		77			46			(20	)		21			(20	)
Amounts in AOCI attributed to pension and postretirement benefit costs, net of deferred taxes		(362	)		(365	)		(365	)		(385	)		(361	)

Total Common Equity Tier 1 capital	$	10,126		$	9,965		$	9,847		$	9,668			9,622

Net risk-weighted assets (regulatory)	$	91,195		$	90,014		$	89,980		$	92,307			89,851
Common Equity Tier 1 ratio (non-GAAP)		11.10	%		11.07	%		10.94	%		10.47	%		10.71	%
Average tangible common equity
Average Key shareholders’ equity (GAAP)	$	11,147		$	10,953		$	10,731		$	10,614		$	10,590
Less: Intangible assets (average) ^(c)		1,076			1,079			1,082			1,083			1,086
Series A Preferred Stock (average)		290			290			290			290			290

Average tangible common equity (non-GAAP)	$	9,781		$	9,584		$	9,359		$	9,241		$	9,214

Return on average tangible common equity from continuing operations
Net income (loss) from continuing operations attributable to Key common shareholders (GAAP)	$	193		$	182		$	224		$	216		$	230
Average tangible common equity (non-GAAP)		9,781			9,584			9,359			9,241			9,214
Return on average tangible common equity from continuing operations (non-GAAP)		7.94	%		7.64	%		9.50	%		9.27	%		10.01	%
Return on average tangible common equity consolidated
Net income (loss) attributable to Key common shareholders (GAAP)	$	196		$	183		$	220		$	213		$	233
Average tangible common equity (non-GAAP)		9,781			9,584			9,359			9,241			9,214
Return on average tangible common equity consolidated (non-GAAP)		8.06	%		7.68	%		9.33	%		9.14	%		10.14	%
Pre-provision net revenue
Net interest income (GAAP)	$	597		$	604		$	602		$	591		$	584
Plus: Taxable-equivalent adjustment		8			8			8			7			7
Noninterest income		473			431			485			470			488
Less: Noninterest expense		751			703			736			724			711

Pre-provision net revenue from continuing operations (non-GAAP)	$	327		$	340		$	359		$	344		$	368

Noninterest expense excluding merger-related expense
Noninterest expense (GAAP)	$	751		$	703		$	736		$	724		$	711
Less: Merger-related expense		45			24			6			—			—

Noninterest expense excluding merger-related expense (non-GAAP)	$	706		$	679		$	730		$	724		$	711

Cash efficiency ratio
Noninterest expense (GAAP)	$	751		$	703		$	736		$	724		$	711
Less: Intangible asset amortization		7			8			9			9			9

Adjusted noninterest expense (non-GAAP)	$	744		$	695		$	727		$	715		$	702
Less: Merger-related expense		45			24			6			—			—

Adjusted noninterest expense excluding merger-related expense (non-GAAP)	$	699		$	671		$	721		$	715		$	702

Net interest income (GAAP)	$	597		$	604		$	602		$	591		$	584
Plus: Taxable-equivalent adjustment		8			8			8			7			7
Noninterest income (GAAP)		473			431			485			470			488

Total taxable-equivalent revenue (non-GAAP)	$	1,078		$	1,043		$	1,095		$	1,068		$	1,079

Cash efficiency ratio (non-GAAP)		69.0	%		66.6	%		66.4	%		66.9	%		65.1	%
Cash efficiency ratio excluding merger-related expense (non-GAAP)		64.8	%		64.3	%		65.8	%		66.9	%		65.1	%
Return on average total assets from continuing operations excluding merger-related expense
Income from continuing operations attributable to Key (GAAP)	$	199		$	187		$	230		$	222		$	235
Add: Merger-related expense, after tax		28			15			4			—			—

Income from continuing operations attributable to Key excluding merger-related expense, after tax (non-GAAP)	$	227		$	202		$	234		$	222		$	235

Average total assets from continuing operations (GAAP)	$	97,413		$	94,477		$	94,117		$	92,649		$	91,658

Return on average total assets from continuing operations excluding merger-related expense (non-GAAP)		.94	%		.86	%		.99	%		.95	%		1.03	%

(a)	For the three months ended June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, and June 30, 2015, intangible assets exclude $36 million, $40 million, $45 million, $50 million, and $55 million, respectively, of period-end purchased credit card receivables.

(b)	Net of capital surplus.

(c)	For the three months ended June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, and June 30, 2015, average intangible assets exclude $38 million, $42 million, $47 million, $52 million, and $58 million, respectively, of average purchased credit card receivables.

Figure 7. GAAP to Non-GAAP Reconciliations, continued


dollars in millions	Three months ended 6-30-16
Common Equity Tier 1 under the Regulatory Capital Rules (estimates)
Common Equity Tier 1 under current Regulatory Capital Rules	$	10,126
Adjustments from current Regulatory Capital Rules to the fully phased-in Regulatory Capital Rules:
Deferred tax assets and other intangible assets^(d)		(21	)

Common Equity Tier 1 anticipated under the fully phased-in Regulatory Capital Rules^(e)	$	10,105

Net risk-weighted assets under current Regulatory Capital Rules	$	91,195
Adjustments from current Regulatory Capital Rules to the fully phased-in Regulatory Capital Rules:
Mortgage servicing assets^(f)		485
Volcker Funds		(224	)
All other assets		17

Total risk-weighted assets anticipated under the fully phased-in Regulatory Capital Rules^(e)	$	91,473

Common Equity Tier 1 ratio under the fully phased-in Regulatory Capital Rules^(e)		11.05	%


	Six months ended
dollars in millions	6-30-16			6-30-15
Pre-provision net revenue
Net interest income (GAAP)	$	1,201		$	1,155
Plus: Taxable-equivalent adjustment		16			13
Noninterest income (GAAP)		904			925
Less: Noninterest expense (GAAP)		1,454			1,380

Pre-provision net revenue from continuing operations (non-GAAP)	$	667		$	713

Average tangible common equity
Average Key shareholders’ equity (GAAP)	$	11,050		$	10,580
Less: Intangible assets (average)^(c)		1,077			1,088
Preferred Stock, Series A (average)		290			290

Average tangible common equity (non-GAAP)	$	9,683		$	9,202

Return on average tangible common equity from continuing operations
Net income (loss) from continuing operations attributable to Key common shareholders (GAAP)	$	375		$	452
Average tangible common equity (non-GAAP)		9,683			9,202
Return on average tangible common equity from continuing operations (non-GAAP)		7.79	%		9.91	%
Return on average tangible common equity consolidated
Net income (loss) attributable to Key common shareholders (GAAP)	$	379		$	460
Average tangible common equity (non-GAAP)		9,683			9,202
Return on average tangible common equity consolidated (non-GAAP)		7.87	%		10.08	%
Cash efficiency ratio
Noninterest expense (GAAP)	$	1,454		$	1,380
Less: Intangible asset amortization (GAAP)		15			18

Adjusted noninterest expense (non-GAAP)		1,439			1,362
Less: Merger-related expense		69			—

	$	1,370		$	1,362

Net interest income (GAAP)	$	1,201		$	1,155
Plus: Taxable-equivalent adjustment		16			13
Noninterest income (GAAP)		904			925

Total taxable-equivalent revenue (non-GAAP)	$	2,121		$	2,093

Cash efficiency ratio (non-GAAP)		67.8	%		65.1	%
Cash efficiency ratio excluding merger-related expense (non-GAAP)		64.6	%		65.1	%
Return on average total assets from continuing operations excluding merger-related expense
Income from continuing operations attributable to Key (GAAP)	$	386		$	463
Add: Merger-related expense, after tax		43			—

Income from continuing operations attributable to Key excluding merger-related expense, after tax (non-GAAP)	$	429		$	463

Average total assets from continuing operations (GAAP)	$	95,945		$	90,648

Return on average total assets from continuing operations excluding merger-related expense (non-GAAP)		.90	%		1.03	%

(d)	Includes the deferred tax assets subject to future taxable income for realization, primarily tax credit carryforwards, as well as intangible assets (other than goodwill and mortgage servicing assets) subject to the transition provisions of the final rule.

(e)	The anticipated amount of regulatory capital and risk-weighted assets is based upon the federal banking agencies’ Regulatory Capital Rules (as fully phased-in on January 1, 2019); we are subject to the Regulatory Capital Rules under the “standardized approach.”

(f)	Item is included in the 10%/15% exceptions bucket calculation and is risk-weighted at 250%.

100

Results of Operations

Net interest income

One of our 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 8 shows the various components of our balance sheet that affect interest income and expense, and their respective yields or rates over the past five quarters. This figure also presents a reconciliation of taxable-equivalent net interest income to net interest income reported in accordance with GAAP for each of those quarters. The net interest margin, which is an indicator of the profitability of the earning assets portfolio less cost of funding, is calculated by dividing annualized taxable-equivalent net interest income by average earning assets.

Taxable-equivalent net interest income was $605 million for the second quarter of 2016, and the net interest margin was 2.76%. These results compare to taxable-equivalent net interest income of $591 million and a net interest margin of 2.88% for the second quarter of 2015. The $14 million increase in net interest income compared to the year-ago quarter reflects higher earning asset balances and an increase in earning asset yields, largely the result of our loan portfolio re-pricing to higher short-term interest rates. The benefit to net interest income from these items was partly offset by lower reinvestment yields in our securities and derivatives portfolios. The 12 basis point decline in the net interest margin reflects higher levels of liquidity, lower reinvestment yields in the securities and derivatives portfolios, and lower loan fees. Our Federal Reserve account averaged $5.6 billion during the second quarter of 2016, which increased $2.3 billion compared to the second quarter of 2015 and reduced the net interest margin by 7 basis points.

For the six months ended June 30, 2016, taxable-equivalent net interest income increased by $49 million, and the net interest margin decreased by 6 basis points. The increase in net interest income reflects higher earning asset balances and an increase in earning asset yields. Higher levels of liquidity and lower reinvestment yields in the securities and derivatives portfolios drove the decline in the net interest margin and more than offset the benefit from higher earning asset yields.

Average loans were $61.1 billion for the second quarter of 2016, an increase of $3.2 billion compared to the second quarter of 2015. The loan growth occurred primarily in the commercial, financial and agricultural portfolio, which increased $3.6 billion and was spread across our commercial lines of business. Consumer loans declined $504 million mostly due to paydowns in our home equity loan portfolio and continued run-off in our consumer exit portfolios.

101

Figure 8. Consolidated Average Balance Sheets, Net Interest Income and Yields/Rates From Continuing Operations

Second Quarter 2016

First Quarter 2016

dollars in millions

Average
Balance

Interest^(a)

Yield/
Rate^(a)

Average
Balance

Interest^(a)

Yield/
Rate^(a)

ASSETS

Loans^{(b), (c)}

Commercial, financial and agricultural^(d)

32,630

270

3.32

31,590

263

3.35

Real estate — commercial mortgage

8,404

3.85

8,138

3.78

Real estate — construction

869

3.78

1,016

4.11

Commercial lease financing

3,949

3.77

3,957

3.65

Total commercial loans

45,852

395

3.47

44,701

386

3.47

Real estate — residential mortgage

2,253

4.11

2,236

4.18

Home equity loans

10,098

102

4.04

10,240

103

4.06

Consumer direct loans

1,599

6.53

1,593

6.53

Credit cards

792

10.58

784

10.72

Consumer indirect loans

554

6.56

602

6.44

Total consumer loans

15,296

180

4.74

15,455

184

4.76

Total loans

61,148

575

3.78

60,156

570

3.80

Loans held for sale

611

3.18

826

4.02

Securities available for sale^(b),
(e)

14,268

2.08

14,207

2.12

Held-to-maturity securities^(b)

4,883

1.98

4,817

2.01

Trading account assets

967

2.28

817

3.50

Short-term investments

5,559

.45

3,432

.46

Other investments^(e)

610

1.54

647

1.73

Total earning assets

88,046

692

3.16

84,902

691

3.27

Allowance for loan and lease losses

(833

)

(803

)

Accrued income and other assets

10,200

10,378

Discontinued assets

1,738

1,804

Total assets

99,151

96,281

LIABILITIES

NOW and money market deposit accounts

39,687

.17

37,708

.16

Savings deposits

2,375

—

.02

2,349

—

.02

Certificates of deposit ($100,000 or more)^(f)

3,233

1.39

2,761

1.37

Other time deposits

3,252

.85

3,200

.79

Total interest-bearing deposits

48,547

.29

46,018

.27

Federal funds purchased and securities sold under repurchase agreements

337

—

.01

437

—

.07

Bank notes and other short-term borrowings

694

1.39

591

1.63

Long-term debt^{(f), (g)}

9,294

2.25

8,566

2.19

Total interest-bearing liabilities

58,872

.60

55,612

.57

Noninterest-bearing deposits

25,357

25,580

Accrued expense and other liabilities

2,032

2,322

Discontinued liabilities^(g)

1,738

1,804

Total liabilities

87,999

85,318

EQUITY

Key shareholders’ equity

11,147

10,953

Noncontrolling interests

Total equity

11,152

10,963

Total liabilities and equity

99,151

96,281

Interest rate spread (TE)

2.56

2.70

Net interest income (TE) and net interest margin (TE)

605

2.76

612

2.89

TE adjustment^(b)

Net interest income, GAAP basis

597

604

(a)	Results are from continuing operations. Interest excludes the interest associated with the liabilities referred to in (g) below, calculated using a matched funds transfer pricing methodology.

(b)	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%.

(c)	For purposes of these computations, nonaccrual loans are included in average loan balances.

(d)

Commercial, financial and agricultural average balances include $87 million, $85 million, $87 million, $88 million, and $88 million of assets from commercial credit cards for the three months ended June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, and June 30, 2015, respectively.

102

Figure 8. Consolidated Average Balance Sheets, Net Interest Income and Yields/Rates From Continuing Operations


Fourth Quarter 2015								Third Quarter 2015								Second Quarter 2015
Average Balance			Interest ^(a)		Yield/ Rate ^(a)			Average Balance			Interest ^(a)		Yield/ Rate ^(a)			Average Balance			Interest ^(a)		Yield/ Rate ^(a)


$	30,884		$	253		3.25	%	$	30,374		$	244		3.19	%	$	29,017		$	233		3.23	%
	8,019			75		3.70			7,988			73		3.65			7,981			74		3.70
	1,067			10		3.65			1,164			11		3.78			1,199			11		3.60
	3,910			36		3.68			3,946			35		3.57			3,981			36		3.58

	43,880			374		3.38			43,472			363		3.32			42,178			354		3.36
	2,252			24		4.18			2,258			24		4.19			2,237			23		4.22
	10,418			105		3.97			10,510			105		3.96			10,510			104		3.98
	1,605			26		6.50			1,597			26		6.53			1,571			26		6.52
	780			21		10.66			759			21		10.74			737			19		10.57
	641			10		6.45			685			11		6.47			745			12		6.38

	15,696			186		4.69			15,809			187		4.69			15,800			184		4.69

	59,576			560		3.72			59,281			550		3.69			57,978			538		3.72
	841			8		4.13			939			10		3.96			1,263			12		3.91
	14,168			76		2.13			14,247			74		2.11			13,360			73		2.17
	4,908			24		1.99			4,923			24		1.95			4,965			24		1.91
	822			6		3.31			699			5		2.50			805			5		2.55
	3,483			3		.28			2,257			1		.26			3,228			2		.26
	674			4		2.71			696			4		2.52			713			5		2.48

	84,472			681		3.21			83,042			668		3.21			82,312			659		3.21
	(790	)							(790	)							(793	)
	10,435								10,397								10,139
	1,947								2,118								2,194

$	96,064							$	94,767							$	93,852


$	37,640			14		.15		$	36,289			15		.16		$	36,122			14		.16
	2,338			—		.02			2,371			—		.02			2,393			—		.02
	2,150			7		1.31			1,985			6		1.27			2,010			6		1.25
	3,047			5		.72			3,064			6		.70			3,136			5		.70
	354			—		.24			492			—		.23			583			1		.23

	45,529			26		.24			44,201			27		.24			44,244			26		.24
	392			—		.02			859			—		.08			557			—		.02
	556			3		1.65			567			2		1.51			657			2		1.39
	8,316			42		2.05			7,893			41		2.20			6,967			40		2.30

	54,793			71		.52			53,520			70		.53			52,425			68		.52
	26,292								26,268								26,594
	2,289								2,236								2,039
	1,947								2,118								2,194

	85,321								84,142								83,252
	10,731								10,614								10,590
	12								11								10

	10,743								10,625								10,600

$	96,064							$	94,767							$	93,852

						2.69	%							2.68	%							2.69	%

				610		2.87	%					598		2.87	%					591		2.88	%

				8								7								7

			$	602							$	591							$	584

(e)	Yield is calculated on the basis of amortized cost.

(f)	Rate calculation excludes basis adjustments related to fair value hedges.

(g)	A portion of long-term debt and the related interest expense is allocated to discontinued liabilities as a result of applying our matched funds transfer pricing methodology to discontinued operations.

103

Figure 9 shows how the changes in yields or rates and average balances from the prior year period affected net interest income. The section entitled “Financial Condition” contains additional discussion about changes in earning assets and funding sources.

Figure 9. Components of Net Interest Income Changes from Continuing Operations


	From three months ended June 30, 2015 to three months ended June 30, 2016									From six months ended June 30, 2015 to six months ended June 30, 2016
in millions	Average Volume			Yield/ Rate			Net Change^(a)			Average Volume			Yield/ Rate			Net Change^(a)
INTEREST INCOME
Loans	$	30		$	7		$	37		$	55		$	23		$	78
Loans held for sale		(6	)		(1	)		(7	)		(6	)		—			(6	)
Securities available for sale		5			(4	)		1			11			(5	)		6
Held-to-maturity securities		—			—			—			(1	)		1			—
Trading account assets		1			—			1			2			1			3
Short-term investments		2			2			4			3			3			6
Other investments		(1	)		(2	)		(3	)		(1	)		(4	)		(5	)

Total interest income (TE)		31			2			33			63			19			82

INTEREST EXPENSE
NOW and money market deposit accounts		1			1			2			2			2			4
Certificates of deposit ($100,000 or more)		4			1			5			7			1			8
Other time deposits		—			2			2			—			2			2
Deposits in foreign office		(1	)		—			(1	)		(1	)		—			(1	)

Total interest-bearing deposits		4			4			8			8			5			13
Bank notes and other short-term borrowings		—			1			1			—			1			1
Long-term debt		13			(3	)		10			26			(7	)		19

Total interest expense		17			2			19			34			(1	)		33

Net interest income (TE)	$	14			—		$	14		$	29		$	20		$	49

(a)	The change in interest not due solely to volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each.

Noninterest income

As shown in Figure 10, noninterest income was $473 million for the second quarter of 2016, compared to $488 million for the year-ago quarter, a decrease of $15 million, or 3.1%. The decrease from the prior year was largely attributable to lower investment banking and debt placement fees of $43 million, reflecting challenging market conditions, as well as $6 million of lower operating lease income and other leasing gains. These declines were offset by an increase in other income of $17 million primarily related to gains from certain real estate investments, along with continued growth in some of our core fee-based business, including corporate services and cards and payments.

For the six months ended June 30, 2016, noninterest income decreased $21 million, or 2.3%, from the same period one year ago. Investment banking and debt placement fees declined $40 million and net gains from principal investing decreased $29 million reflecting market weakness. These decreases were partially offset by increases of $17 million in corporate services income due to higher loan commitment fees, other non-yield loans fees, and dealer trading and derivatives income, and $29 million in other income.

Figure 10. Noninterest Income


	Three months ended June 30,				Change						Six months ended June 30,				Change
dollars in millions	2016		2015		Amount			Percent			2016		2015		Amount			Percent
Trust and investment services income	$	110	$	111	$	(1	)		(.9	)%	$	219	$	220	$	(1	)		(.5	)%
Investment banking and debt placement fees		98		141		(43	)		(30.5	)		169		209		(40	)		(19.1	)
Service charges on deposit accounts		68		63		5			7.9			133		124		9			7.3
Operating lease income and other leasing gains		18		24		(6	)		(25.0	)		35		43		(8	)		(18.6	)
Corporate services income		53		43		10			23.3			103		86		17			19.8
Cards and payments income		52		47		5			10.6			98		89		9			10.1
Corporate-owned life insurance income		28		30		(2	)		(6.7	)		56		61		(5	)		(8.2	)
Consumer mortgage income		3		4		(1	)		(25.0	)		5		7		(2	)		(28.6	)
Mortgage servicing fees		10		9		1			11.1			22		22		—			—
Net gains (losses) from principal investing		11		11		—			—			11		40		(29	)		(72.5	)
Other income^(a)		22		5		17			340.0			53		24		29			120.8

Total noninterest income	$	473	$	488	$	(15	)		(3.1	)%	$	904	$	925	$	(21	)		(2.3	)%

(a)	Included in this line item is our “Dealer trading and derivatives income (loss).” Additional detail is provided in Figure 11.

104

Figure 11. Dealer Trading and Derivatives Income (Loss)


	Three months ended June 30,					Change						Six months ended June 30,					Change
dollars in millions	2016		2015			Amount			Percent			2016		2015			Amount		Percent
Dealer trading and derivatives income (loss), proprietary^(a),^(b)	$	1	$	(4	)	$	5			N/M			—	$	(5	)	$	5		N/M
Dealer trading and derivatives income (loss), nonproprietary^(b)		1		2			(1	)		(50.0	)%	$	10		5			5		100.0	%

Total dealer trading and derivatives income (loss)	$	2	$	(2	)	$	4			N/M		$	10		—		$	10		100.0	%

(a)

For the quarter ended June 30, 2016, income of $3 million related to fixed income, foreign exchange, interest rates, and commodity derivative trading was offset by losses related to equity securities trading and credit portfolio management activities. For the quarter ended June 30, 2015, income of $1 million related to foreign exchange, interest rate, fixed income, and commodity derivative trading was offset by losses related to equity securities trading and credit portfolio management activities.

(b)

The allocation between proprietary and nonproprietary is made based upon whether the trade is conducted for the benefit of Key or Key’s clients rather than based upon rulemaking under the Volcker Rule. For more information on prohibitions and restrictions imposed by the Volcker Rule, see the discussion under the heading “Other Regulatory Developments under the Dodd-Frank Act – ‘Volcker Rule’” in the section entitled “Supervision and Regulation” in Item 1 of our 2015 Form 10-K.

The following discussion explains the composition of certain elements of our noninterest income and the factors that caused those elements to change.

Trust and investment services income

Trust and investment services income is one of our largest sources of noninterest income and consists of brokerage commissions, trust and asset management commissions, and insurance income. The assets under management that primarily generate these revenues are shown in Figure 12. For the three and six months ended June 30, 2016, trust and investment services income decreased $1 million, or ..9% and .5%, respectively. These declines were due to lower trust and asset management commissions, partially offset by an increase in insurance income.

A significant portion of our trust and investment services income depends on the value and mix of assets under management. At June 30, 2016, our bank, trust, and registered investment advisory subsidiaries had assets under management of $34.5 billion, compared to $38.4 billion at June 30, 2015. The decreases in the equity and securities lending, as shown in Figure 12, were primarily attributable to client attrition and market declines. These declines were partially offset by increases in the money market and fixed income portfolios.

Figure 12. Assets Under Management


	2016				2015
in millions	Second		First		Fourth		Third		Second
Assets under management by investment type:
Equity	$	20,458	$	20,210	$	20,199	$	19,728	$	21,226
Securities lending		968		1,147		1,215		2,872		4,438
Fixed income		10,053		9,789		9,705		9,823		9,899
Money market		3,056		2,961		2,864		2,735		2,836

Total	$	34,535	$	34,107	$	33,983	$	35,158	$	38,399

Investment banking and debt placement fees

Investment banking and debt placement fees consist of syndication fees, debt and equity financing fees, financial advisor fees, gains on sales of commercial mortgages, and agency origination fees. Investment banking and debt placement fees decreased $43 million, or 30.5%, for the second quarter of 2016, and $40 million, or 19.1%, for the six months ended June 30, 2016, compared to the same periods one year ago. These decreases were primarily attributable to a decline in merger and acquisition advisory fees and a decline in gains on sales of commercial mortgages reflecting challenging market conditions.

Service charges on deposit accounts

Service charges on deposit accounts increased $5 million, or 7.9%, and $9 million, or 7.3%, from the three and six months ended June 30, 2016, compared to the same periods one year ago. These increases were primarily due to higher overdraft and account analysis fees.

105

Operating lease income and other leasing gains

Operating lease income and other leasing gains decreased $6 million, or 25%, for the second quarter of 2016, and $8 million, or 18.6%, for the six months ended June 30, 2016, compared to the same periods one year ago. These declines were primarily due to lower gains realized on the sale of returned leased equipment. The expense related to the rental of leased equipment is presented in Figure 13 as “operating lease expense.”

Corporate services income

Corporate services income increased $10 million, or 23.3%, from the year-ago quarter, and $17 million, or 19.8%, for the six months ended June 30, 2016, compared to the same period one year ago. These increases were driven by higher non-yield loan fees, dealer trading and derivatives income, and foreign exchange trading income.

Cards and payments income

Cards and payments income, which consists of debit card, consumer and commercial credit card, and merchant services income, increased $5 million, or 10.6%, from the year-ago quarter, and $9 million, or 10.1%, for the six months ended June 30, 2016, compared to the same period one year ago. This increase was due to higher purchase card, credit card, and ATM debit card fees driven by increased volume.

Consumer mortgage income

Consumer mortgage income decreased $1 million, or 25%, from the year-ago quarter, and $2 million, or 28.6%, for the six months ended June 30, 2016, compared to the same period one year ago. These decreases were primarily due to lower gains on consumer mortgage loans sold.

Mortgage servicing fees

Mortgage servicing fees increased $1 million, or 11.1%, from the year-ago quarter, and were flat for the six months ended June 30, 2016, compared to the same period one year ago. The increase from the year-ago quarter was driven by increased service fee income on mortgage loans sold.

Other income

Other income, which consists primarily of gains on sales of loans held for sale, other service charges, and certain dealer trading income, increased $17 million, or 340%, from the year-ago quarter, and $29 million, or 120.8%, for the six months ended June 30, 2016, compared to the same period one year ago. These increases were primarily due to gains from certain real estate investments.

106

Noninterest expense

As shown in Figure 13, noninterest expense was $751 million for the second quarter of 2016, compared to $711 million for the year-ago quarter, representing an increase of $40 million, or 5.6%. Noninterest expense included $45 million of merger-related expense, primarily made up of $35 million in personnel expense related to technology development for systems conversions and fully dedicated personnel for acquisition and integration efforts. The remaining $10 million of merger-related expense was nonpersonnel expense, largely recognized in business services and professional fees and marketing. There was no merger-related expense incurred in the second quarter of 2015.

Excluding merger-related expense, noninterest expense was $5 million lower than the second quarter of 2015. The decrease is primarily attributable to $16 million in lower personnel expense related to lower performance based compensation, along with lower net occupancy expenses and business services and professional fees. These decreases were partially offset by an increase in other expense, reflecting the impact of certain real estate investments and other miscellaneous items, along with increased non-merger related marketing expense.

For the six months ended June 30, 2016, noninterest expense increased $74 million, or 5.4%, compared to the same period one year ago. Noninterest expense included $69 million of merger-related expense, primarily made up of $51 million in personnel expense and $18 million of nonpersonnel expense.

Excluding merger-related expense, noninterest expense for the six months ended June 30, 2016, was $5 million higher than the same period one year ago. Other expense increased $26 million, reflecting the impact of certain real estate investments, and computer processing expenses increased $8 million. These increases were partially offset by lower personnel expense related to lower performance based compensation, along with lower net occupancy expenses.

Figure 13. Noninterest Expense


	Three months ended June 30,				Change						Six months ended June 30,				Change
dollars in millions	2016		2015		Amount			Percent			2016		2015		Amount			Percent
Personnel^(a)	$	427	$	408	$	19			4.7	%	$	831	$	797	$	34			4.3	%
Net occupancy		59		66		(7	)		(10.6	)		120		131		(11	)		(8.4	)
Computer processing		45		42		3			7.1			88		80		8			10.0
Business services and professional fees		40		42		(2	)		(4.8	)		81		75		6			8.0
Equipment		21		22		(1	)		(4.5	)		42		44		(2	)		(4.5	)
Operating lease expense		14		12		2			16.7			27		23		4			17.4
Marketing		22		15		7			46.7			34		23		11			47.8
FDIC assessment		8		8		—			—			17		16		1			6.3
Intangible asset amortization		7		9		(2	)		(22.2	)		15		18		(3	)		(16.7	)
OREO expense, net		2		1		1			100.0			3		3		—			—
Other expense		106		86		20			23.3			196		170		26			15.3

Total noninterest expense	$	751	$	711	$	40			5.6	%	$	1,454	$	1,380	$	74			5.4	%

Merger-related expense^(b)		45		—		45			N/M			69		—		69			N/M

Total noninterest expense excluding merger- related expense^(c)	$	706	$	711	$	(5	)		(.7	)%	$	1,385	$	1,380	$	5			.4	%

Average full-time equivalent employees^(d)		13,419		13,455		(36	)		(.3	)%		13,411		13,512		(101	)		(.7	)%

(a)	Additional detail provided in Figure 15 entitled “Personnel Expense.”

(b)	Additional detail provided in Figure 14 entitled “Merger-Related Expense.”

(c)	Non-GAAP measure. See Figure 7 entitled “GAAP to Non-GAAP Reconciliations.”

(d)	The number of average full-time equivalent employees has not been adjusted for discontinued operations.

Figure 14. Merger-Related Expense


	Three months ended June 30,				Change				Six months ended June 30,				Change
dollars in millions	2016		2015		Amount		Percent		2016		2015		Amount		Percent
Personnel^(a)	$	35		—	$	35		N/M	$	51		—	$	51		N/M
Business services and professional fees		5		—		5		N/M		12		—		12		N/M
Marketing		3		—		3		N/M		4		—		4		N/M
Other nonpersonnel expense		2		—		2		N/M		2		—		2		N/M

Total merger-related expense	$	45		—	$	45		N/M	$	69		—	$	69		N/M

(a)	Personnel expense includes technology development related to systems conversions, as well as fully-dedicated personnel for merger and integration efforts.

107

Personnel

As shown in Figure 15, personnel expense, the largest category of our noninterest expense, increased by $19 million, or 4.7%, for the second quarter of 2016 compared to the year-ago quarter. For the six months ended June 30, 2016, personnel expense increased $34 million, or 4.3% from the same period one year ago. Personnel expense included $35 million for the second quarter of 2016, and $51 million for the six months ended June 30, 2016, of merger-related expense related to technology development for system conversions and fully dedicated personnel for acquisition and integration efforts. Personnel expense, adjusting for merger-related expense, declined $16 million from the year-ago quarter, and $17 million for the six months ended June 30, 2016, compared to the same period one year ago. These decreases were primarily due to lower performance based compensation and lower severance costs.

Figure 15. Personnel Expense


	Three months ended June 30,				Change						Six months ended June 30,				Change
dollars in millions	2016		2015		Amount			Percent			2016		2015		Amount			Percent
Salaries and contract labor	$	266	$	239	$	27			11.3	%	$	510	$	467	$	43			9.2	%
Incentive and stock-based compensation		101		109		(8	)		(7.3	)		190		192		(2	)		(1.0	)
Employee benefits		58		55		3			5.5			126		127		(1	)		(.8	)
Severance		2		5		(3	)		(60.0	)		5		11		(6	)		(54.5	)

Total personnel expense	$	427	$	408	$	19			4.7	%	$	831	$	797	$	34			4.3	%

Net occupancy

Net occupancy expense decreased $7 million, or 10.6 %, for the second quarter of 2016, and $11 million, or 8.4%, for the six months ended June 30, 2016, compared to the same periods one year ago. These declines were primarily due to lower rental expenses.

Operating lease expense

Operating lease expense increased $2 million, or 16.7%, from the year-ago quarter, and $4 million, or 17.4%, from the six-month period ended one year ago. These increases were due to increased depreciation expense on operating lease equipment. Income related to the rental of leased equipment is presented in Figure 10 as “operating lease income and other leasing gains.”

Other expense

Other expense comprises various miscellaneous expense items. The $20 million, or 23.3%, increase in the current quarter and the $26 million, or 15.3%, increase in the first six months of 2016 compared to the same periods one year ago reflect the impact of certain real estate investments and other miscellaneous expenses.

Income taxes

We recorded tax expense from continuing operations of $69 million for the second quarter of 2016 and $84 million for the second quarter of 2015. For the first six months of 2016, we recorded tax expense from continuing operations of $125 million, compared to $158 million for the same period one year ago.

Our federal tax expense (benefit) differs from the amount that would be calculated using the federal statutory tax rate, primarily because we generate income from investments in tax-advantaged assets, such as corporate-owned life insurance, and credits associated with renewable energy and low-income housing investments.

Additional information pertaining to how our tax expense (benefit) and the resulting effective tax rates were derived is included in Note 12 (“Income Taxes”) beginning on page 184 of our 2015 Form 10-K.

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Line of Business Results

This section summarizes the financial performance and related strategic developments of our two major business segments (operating segments): Key Community Bank and Key Corporate Bank. Note 18 (“Line of Business Results”) describes the products and services offered by each of these business segments, provides more detailed financial information pertaining to the segments, and explains “Other Segments” and “Reconciling Items.”

Figure 16 summarizes the contribution made by each major business segment to our “taxable-equivalent revenue from continuing operations” and “income (loss) from continuing operations attributable to Key” for the three-month periods ended June 30, 2016, and June 30, 2015.

Figure 16. Major Business Segments — Taxable-Equivalent (TE) Revenue from Continuing Operations and Income (Loss) from Continuing Operations Attributable to Key


	Three months ended June 30,						Change						Six months ended June 30,						Change
dollars in millions	2016			2015			Amount			Percent			2016			2015			Amount			Percent
REVENUE FROM CONTINUING OPERATIONS (TE)
Key Community Bank	$	598		$	560		$	38			6.8	%	$	1,193		$	1,108		$	85			7.7	%
Key Corporate Bank		452			478			(26	)		(5.4	)		877			880			(3	)		(.3	)
Other Segments		31			43			(12	)		(27.9	)		52			109			(57	)		(52.3	)

Total Segments		1,081			1,081			—			—			2,122			2,097			25			1.2
Reconciling Items		(3	)		(2	)		(1	)		N/M			(1	)		(4	)		3			N/M

Total	$	1,078		$	1,079		$	(1	)		(0.1	)%	$	2,121		$	2,093		$	28			1.3	%

INCOME (LOSS) FROM CONTINUING OPERATIONS ATTRIBUTABLE TO KEY
Key Community Bank	$	81		$	69		$	12			17.4	%	$	154		$	120		$	34			28.3	%
Key Corporate Bank		135			131			4			3.1			254			258			(4	)		(1.6	)
Other Segments		24			31			(7	)		(22.6	)		38			74			(36	)		(48.6	)

Total Segments		240			231			9			3.9			446			452			(6	)		(1.3	)
Reconciling Items		(41	)		4			(45	)		N/M			(60	)		11			(71	)		N/M

Total	$	199		$	235		$	(36	)		(15.3	)%	$	386		$	463		$	(77	)		(16.6	)%

Key Community Bank summary of operations

•

Positive operating leverage from prior year

•

Net income increased to $81 million, 17.4% growth from prior year

•

Commercial, financial and agricultural average loan growth of $675 million, or 5.4% from prior year

•

Average deposits up $3 billion, or 6.0% from the prior year

As shown in Figure 17, Key Community Bank recorded net income attributable to Key of $81 million for the second quarter of 2016, compared to net income attributable to Key of $69 million for the year-ago quarter.

Taxable-equivalent net interest income increased by $29 million, or 8.0%, from the second quarter of 2015 due to favorable deposit rates and balance growth. Average deposits increased $3 billion, or 6.0%, from one year ago, and average loans and leases grew $229 million, or .7%. Commercial, financial and agricultural loans grew by $675 million, or 5.4%, from the prior year.

Noninterest income increased $9 million, or 4.5%, from the year-ago quarter. Service charges on deposit accounts increased $4 million, and cards and payments income and investment banking and debt placement fees each increased $3 million. These increases were partially offset by market weakness affecting Key’s Private Bank as well as lower consumer mortgage income.

The provision for credit losses increased by $22 million from the second quarter of 2015. Net loan charge-offs decreased $3 million from the same period one year ago.

Noninterest expense remained relatively stable, decreasing by $3 million, or .7%, from the year-ago quarter.

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Figure 17. Key Community Bank


	Three months ended June 30,				Change						Six months ended June 30,				Change
dollars in millions	2016		2015		Amount			Percent			2016		2015		Amount			Percent
SUMMARY OF OPERATIONS
Net interest income (TE)	$	391	$	362	$	29			8.0	%	$	790	$	720	$	70			9.7	%
Noninterest income		207		198		9			4.5			403		388		15			3.9

Total revenue (TE)		598		560		38			6.8			1,193		1,108		85			7.7
Provision for credit losses		25		3		22			733.3			66		32		34			106.3
Noninterest expense		444		447		(3	)		(.7	)		881		884		(3	)		(.3	)

Income (loss) before income taxes (TE)		129		110		19			17.3			246		192		54			28.1
Allocated income taxes (benefit) and TE adjustments		48		41		7			17.1			92		72		20			27.8

Net income (loss) attributable to Key	$	81	$	69	$	12			17.4	%	$	154	$	120	$	34			28.3	%

AVERAGE BALANCES
Loans and leases	$	30,936	$	30,707	$	229			.7	%	$	30,863	$	30,684	$	179			.6	%
Total assets		32,963		32,809		154			.5			32,910		32,789		121			.4
Deposits		53,794		50,765		3,029			6.0			53,299		50,591		2,708			5.4
Assets under management at period end	$	34,535	$	38,399	$	(3,864	)		(10.1	)%	$	34,535	$	38,399	$	(3,864	)		(10.1	)%

ADDITIONAL KEY COMMUNITY BANK DATA


	Three months ended June 30,						Change						Six months ended June 30,				Change
dollars in millions	2016			2015			Amount			Percent			2016		2015		Amount			Percent
NONINTEREST INCOME
Trust and investment services income	$	73		$	76		$	(3	)		(3.9	)%	$	146	$	150	$	(4	)		(2.7	)%
Services charges on deposit accounts		56			52			4			7.7			110		103		7			6.8
Cards and payments income		46			43			3			7.0			89		80		9			11.3
Other noninterest income		32			27			5			18.5			58		55		3			5.5

Total noninterest income	$	207		$	198		$	9			4.5	%	$	403	$	388	$	15			3.9	%

AVERAGE DEPOSITS OUTSTANDING
NOW and money market deposit accounts	$	30,144		$	28,284		$	1,860			6.6	%	$	29,788	$	28,080	$	1,708			6.1	%
Savings deposits		2,365			2,385			(20	)		(.8	)		2,353		2,381		(28	)		(1.2	)
Certificates of deposits ($100,000 or more)		2,383			1,547			836			54.0			2,251		1,552		699			45.0
Other time deposits		3,245			3,132			113			3.6			3,221		3,171		50			1.6
Deposits in foreign office		—			299			(299	)		N/M			—		316		(316	)		N/M
Noninterest-bearing deposits		15,657			15,118			539			3.6			15,686		15,091		595			3.9

Total deposits	$	53,794		$	50,765		$	3,029			6.0	%	$	53,299	$	50,591	$	2,708			5.4	%

HOME EQUITY LOANS
Average balance	$	9,908		$	10,266
Combined weighted-average loan-to-value ratio (at date of origination)		71	%		71	%
Percent first lien positions		61			60

OTHER DATA
Branches		949			989
Automated teller machines		1,236			1,280

Key Corporate Bank summary of operations

•

Average loan and lease balances up $3.3 billion, or 13.1% from the prior year

•

Net income increased to $135 million, 3.1% growth from the prior year

As shown in Figure 18, Key Corporate Bank recorded net income attributable to Key of $135 million for the second quarter of 2016, compared to $131 million for the same period one year ago.

Taxable-equivalent net interest income decreased by $6 million, or 2.6%, compared to the second quarter of 2015. Average loan and lease balances increased $3.3 billion, or 13.1%, from the year-ago quarter, primarily driven by growth in commercial, financial and agricultural loans. This loan growth was offset by spread compression due to higher funding costs and a decline in loan fees due to lower refinance activity from the prior year. Average deposit balances decreased $580 million, or 2.9%, from the year-ago quarter, mostly driven by lower public deposits.

Noninterest income was down $20 million, or 8.0%, from the prior year. Investment banking and debt placement fees declined $45 million, or 32.4%, due to challenging market conditions. Other noninterest income increased $15 million from the year-ago quarter mostly due to gains from certain real estate investments. Corporate services income was up $7 million, or 21.2%, due to growth in commitment fees and derivatives.

110

The provision for credit losses decreased $11 million, or 26.8%, compared to the second quarter of 2015 as lower provisioning related to unfunded commitments offset higher net loan charge-offs.

Noninterest expense increased by $3 million, or 1.2%, from the second quarter of 2015. Increases in various other expense items, including operating lease expense, were partially offset by lower personnel costs.

Figure 18. Key Corporate Bank


	Three months ended June 30,					Change						Six months ended June 30,					Change
dollars in millions	2016			2015		Amount			Percent			2016			2015		Amount			Percent
SUMMARY OF OPERATIONS
Net interest income (TE)	$	222		$	228	$	(6	)		(2.6	)%	$	440		$	442	$	(2	)		(.5	)%
Noninterest income		230			250		(20	)		(8.0	)		437			438		(1	)		(.2	)

Total revenue (TE)		452			478		(26	)		(5.4	)		877			880		(3	)		(.3	)
Provision for credit losses		30			41		(11	)		(26.8	)		73			47		26			55.3
Noninterest expense		259			256		3			1.2			495			475		20			4.2

Income (loss) before income taxes (TE)		163			181		(18	)		(9.9	)		309			358		(49	)		(13.7	)
Allocated income taxes and TE adjustments		29			50		(21	)		(42.0	)		57			99		(42	)		(42.4	)

Net income (loss)		134			131		3			2.3			252			259		(7	)		(2.7	)
Less: Net income (loss) attributable to noncontrolling interests		(1	)		—		(1	)		N/M			(2	)		1		(3	)		N/M

Net income (loss) attributable to Key	$	135		$	131	$	4			3.1	%	$	254		$	258	$	(4	)		(1.6	)%

AVERAGE BALANCES
Loans and leases	$	28,607		$	25,298	$	3,309			13.1	%	$	28,164		$	25,012	$	3,152			12.6	%
Loans held for sale		591			1,234		(643	)		(52.1	)		701			1,006		(305	)		(30.3	)
Total assets		33,909			31,173		2,736			8.8			33,661			30,709		2,952			9.6
Deposits		19,129			19,709		(580	)		(2.9	)		18,602			19,142		(540	)		(2.8	)

ADDITIONAL KEY CORPORATE BANK DATA


	Three months ended June 30,				Change						Six months ended June 30,				Change
dollars in millions	2016		2015		Amount			Percent			2016		2015		Amount			Percent
NONINTEREST INCOME
Trust and investment services income	$	37	$	35	$	2			5.7	%	$	73	$	70	$	3			4.3	%
Investment banking and debt placement fees		94		139		(45	)		(32.4	)		164		207		(43	)		(20.8	)
Operating lease income and other leasing gains		15		18		(3	)		(16.7	)		28		32		(4	)		(12.5	)
Corporate services income		40		33		7			21.2			78		65		13			20.0
Service charges on deposit accounts		12		11		1			9.1			23		21		2			9.5
Cards and payments income		6		4		2			50.0			9		8		1			12.5

Payments and services income		58		48		10			20.8			110		94		16			17.0
Mortgage servicing fees		10		9		1			11.1			22		22		—			—
Other noninterest income		16		1		15			N/M			40		13		27			207.7

Total noninterest income	$	230	$	250	$	(20	)		(8.0	)%	$	437	$	438	$	(1	)		(.2	)%

Other Segments

Other Segments consist of Corporate Treasury, Key’s Principal Investing unit and various exit portfolios. Other Segments generated net income attributable to Key of $24 million for the second quarter of 2016, compared to $31 million for the same period last year. This decline was largely attributable to spread compression.

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Financial Condition

Loans and loans held for sale

At June 30, 2016, total loans outstanding from continuing operations were $62.1 billion, compared to $59.9 billion at December 31, 2015, and $58.3 billion at June 30, 2015. The increase in our outstanding loans from continuing operations over the past twelve months results primarily from increased lending activity in our commercial, financial and agricultural and commercial mortgage portfolios. Loans related to the discontinued operations of the education lending business, which are excluded from total loans at June 30, 2016, December 31, 2015, and June 30, 2015, totaled $1.7 billion, $1.8 billion, and $2 billion, respectively. For more information on balance sheet carrying value, see Note 1 (“Summary of Significant Accounting Policies”) under the headings “Loans” and “Loans Held for Sale” on page 121 of our 2015 Form 10-K.

Commercial loan portfolio

Commercial loans outstanding were $46.8 billion at June 30, 2016, an increase of $4.4 billion, or 10.4%, compared to June 30, 2015.

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Figure 19 provides our commercial loan portfolios by industry classification at June 30, 2016, December 31, 2015, and June 30, 2015.

Figure 19. Commercial Loans by Industry


June 30, 2016 dollars in millions	Commercial, financial and agricultural		Commercial real estate		Commercial lease financing		Total commercial loans		Percent of total
Industry classification:
Agricultural	$	697	$	155	$	147	$	999		2.1	%
Automotive		1,799		440		66		2,305		4.9
Business products		1,127		111		31		1,269		2.7
Business services		2,387		109		281		2,777		5.9
Commercial real estate		4,317		5,685		2		10,004		21.4
Construction materials and contractors		905		142		64		1,111		2.4
Consumer discretionary		2,754		337		247		3,338		7.1
Consumer services		1,696		403		68		2,167		4.6
Equipment		1,304		70		83		1,457		3.1
Financial		3,342		65		252		3,659		7.8
Healthcare		2,928		1,462		452		4,842		10.3
Materials manufacturing and mining		2,430		162		185		2,777		5.9
Media		321		32		68		421		.9
Oil and gas		1,083		56		54		1,193		2.5
Public exposure		1,592		144		877		2,613		5.6
Technology		402		4		16		422		.9
Transportation		781		82		840		1,703		3.6
Utilities		3,092		3		255		3,350		7.2
Other		419		1		—		420		.9

Total	$	33,376	$	9,463	$	3,988	$	46,827		100.0	%


December 31, 2015 dollars in millions	Commercial, financial and agricultural		Commercial real estate		Commercial lease financing		Total commercial loans		Percent of total
Industry classification:
Agricultural	$	745	$	147	$	143	$	1,035		2.3	%
Automotive		1,736		387		31		2,154		4.9
Business products		1,093		115		40		1,248		2.8
Business services		2,222		116		293		2,631		5.9
Commercial real estate		3,906		5,387		2		9,295		21.0
Construction materials and contractors		750		141		67		958		2.2
Consumer discretionary		2,521		347		270		3,138		7.1
Consumer services		1,683		452		73		2,208		5.0
Equipment		1,170		79		50		1,299		2.9
Financial		3,347		68		270		3,685		8.3
Healthcare		3,089		1,281		493		4,863		11.0
Materials manufacturing and mining		2,074		164		183		2,421		5.5
Media		349		22		88		459		1.0
Oil and gas		1,080		52		67		1,199		2.7
Public exposure		1,477		148		856		2,481		5.6
Technology		354		5		22		381		.9
Transportation		806		90		836		1,732		3.9
Utilities		2,482		5		236		2,723		6.2
Other		356		6		—		362		.8

Total	$	31,240	$	9,012	$	4,020	$	44,272		100.0	%


June 30, 2015 dollars in millions	Commercial, financial and agricultural		Commercial real estate		Commercial lease financing		Total commercial loans		Percent of total
Industry classification:
Agricultural	$	682	$	143	$	126	$	951		2.2	%
Automotive		1,680		410		43		2,133		5.0
Business products		1,142		124		39		1,305		3.1
Business services		2,102		122		298		2,522		5.9
Commercial real estate		3,341		5,392		3		8,736		20.6
Construction materials and contractors		779		151		66		996		2.3
Consumer discretionary		2,564		332		250		3,146		7.4
Consumer services		1,549		481		75		2,105		5.0
Equipment		1,204		77		67		1,348		3.2
Financial		2,940		64		258		3,262		7.7
Healthcare		2,652		1,306		509		4,467		10.5
Materials manufacturing and mining		2,244		169		177		2,590		6.1
Media		350		16		100		466		1.1
Oil and gas		987		44		63		1,094		2.6
Public exposure		1,389		184		838		2,411		5.7
Technology		326		5		11		342		.8
Transportation		859		93		855		1,807		4.3
Utilities		2,133		4		232		2,369		5.6
Other		362		11		—		373		.9

Total	$	29,285	$	9,128	$	4,010	$	42,423		100.0	%

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Commercial, financial and agricultural. Our commercial, financial and agricultural loans, also referred to as “commercial and industrial,” represented 54% of our total loan portfolio at June 30, 2016, 52% at December 31, 2015, and 50% at June 30, 2015, and is the largest component of our total loans. These loans are originated by both Key Corporate Bank and Key Community Bank and consist of fixed and variable rate loans to our large, middle market, and small business clients.

Commercial, financial and agricultural loans increased $4.1 billion, or 14%, from the same period last year, with Key Corporate Bank increasing $3.6 billion, Key Community Bank up $474 million, and Other Segments increasing $4 million. We have experienced growth in new high credit quality loan commitments and utilization with clients in our middle market segment and Institutional and Capital Markets business. Our two largest industry classifications — commercial real estate and financial — increased by 29.2% and 13.7%, respectively, when compared to one year ago. The commercial real estate and financial industries represented approximately 13% and 10%, respectively, of the total commercial, financial and agricultural loan portfolio at June 30, 2016, and approximately 11% and 10%, respectively, at June 30, 2015. In addition, utilities and healthcare, which each represented approximately 9% of the commercial, financial and agricultural loan portfolio at June 30, 2016, increased 45% and 10.4%, respectively, from one year ago. Utilities were higher due to alternative energy project financings, which predominantly rely directly or indirectly on the creditworthiness of public utilities. Healthcare grew due to a focus on more institutional-scale sponsor/owners of skilled nursing and assisted living facilities.

Our oil and gas loan portfolio focuses on lending to middle market companies and represents approximately 2% of total loans outstanding at June 30, 2016. Our oil and gas portfolio represented $1.1 billion of outstanding commercial, financial and agricultural loans at June 30, 2016. In addition, the commercial real estate and commercial lease financing loan portfolios also include $56 million and $54 million, respectively, of outstanding oil and gas loans at June 30, 2016. We have nearly 15 years of experience in energy lending with over 20 specialists dedicated to this sector, focusing on middle market companies, which is aligned with our relationship strategy.

The upstream segment, comprising oil and gas exploration and production, represents approximately 57% of our exposure, is primarily secured by oil and gas reserves, subject to a borrowing base, and regularly stress-tested. The midstream segment, comprising mostly distribution companies, has lower exposure to commodity risk. Oil field services exposure is minimal and concentrated in very few borrowers. This mix was essentially unchanged from the prior year. Our total commitments in the oil and gas sector were approximately $3.1 billion at June 30, 2016.

Commercial real estate loans. Our commercial real estate lending business is conducted through two primary sources: our 12-state banking franchise, and KeyBank Real Estate Capital, a national line of business that cultivates relationships with owners of commercial real estate located both within and beyond the branch system. This line of business deals primarily with nonowner-occupied properties (generally properties for which at least 50% of the debt service is provided by rental income from nonaffiliated third parties) and accounted for approximately 70% of our average year-to-date commercial real estate loans, compared to 67% one year ago. KeyBank Real Estate Capital generally focuses on larger owners and operators of commercial real estate.

Commercial real estate loans totaled $9.5 billion at June 30, 2016, and $9.1 billion at June 30, 2015, and represented 15% and 16% of our total loan portfolio at June 30, 2016, and June 30, 2015, respectively. These loans, which include both owner- and nonowner-occupied properties, represented 20% and 22% of our commercial loan portfolio at June 30, 2016, and June 30, 2015, respectively. We continue to de-risk the portfolio by changing our focus from developers to owners of completed and stabilized commercial real estate.

Figure 20 includes commercial mortgage and construction loans in both Key Community Bank and Key Corporate Bank. As shown in Figure 20, this loan portfolio is diversified by both property type and geographic location of the underlying collateral.

As presented in Figure 20, at June 30, 2016, our commercial real estate portfolio included mortgage loans of $8.6 billion and construction loans of $881 million, representing 14% and 1%, respectively, of our total loans. At June 30, 2016, nonowner-occupied loans represented 11% of our total loans and owner-occupied loans represented 4% of our total loans. The average size of mortgage loans originated during the second quarter of 2016 was $8.8 million, and our largest mortgage loan at June 30, 2016, had a balance of $109.5 million. At June 30, 2016, our average construction loan commitment was $7.9 million, our largest construction loan commitment was $50.5 million, and our largest construction loan amount outstanding was $30.1 million.

Also shown in Figure 20, 74% of our commercial real estate loans at June 30, 2016, were for nonowner-occupied properties compared to 71% at June 30, 2015. Approximately 12% of these loans were construction loans at June 30, 2016, compared

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to 17% at June 30, 2015. Typically, these properties are not fully leased at the origination of the loan. The borrower relies upon additional leasing through the life of the loan to provide the cash flow necessary to support debt service payments. A significant decline in economic growth, and in turn rental rates and occupancy, would adversely affect our portfolio of construction loans.

Figure 20. Commercial Real Estate Loans


	Geographic Region														Total		Percent of Total			Construction		Commercial Mortgage
dollars in millions	West		Southwest		Central		Midwest		Southeast		Northeast		National		Total		Percent of Total			Construction		Commercial Mortgage
June 30, 2016
Nonowner-occupied:
Retail properties	$	231	$	66	$	79	$	149	$	192	$	89	$	168	$	974		10.3	%	$	77	$	897
Multifamily properties		370		185		528		579		1,086		156		169		3,073		32.5			500		2,573
Health facilities		248		—		134		89		471		237		49		1,228		13.0			83		1,145
Office buildings		76		7		153		116		120		49		3		524		5.5			33		491
Warehouses		104		8		45		99		60		77		185		578		6.1			60		518
Manufacturing facilities		6		—		2		10		16		3		58		95		1.0			—		95
Hotels/Motels		70		—		16		6		—		6		—		98		1.0			—		98
Residential properties		1		—		45		5		—		7		—		58		.6			24		34
Land and development		9		—		1		3		9		3		—		25		.3			18		7
Other		60		12		3		13		46		94		133		361		3.8			12		349

Total nonowner-occupied		1,175		278		1,006		1,069		2,000		721		765		7,014		74.1			807		6,207
Owner-occupied		904		—		339		592		14		600		—		2,449		25.9			74		2,375

Total	$	2,079	$	278	$	1,345	$	1,661	$	2,014	$	1,321	$	765	$	9,463		100.0	%	$	881	$	8,582

December 31, 2015
Total	$	2,163	$	277	$	1,309	$	1,671	$	1,721	$	1,282	$	589	$	9,012				$	1,053	$	7,959

June 30, 2015
Total	$	2,424	$	240	$	1,390	$	1,660	$	1,473	$	1,349	$	592	$	9,128				$	1,254	$	7,874

June 30, 2016
Nonowner-occupied:
Nonperforming loans		—		—	$	17	$	5		—	$	4		—	$	26		N/M		$	19	$	7
Accruing loans past due 90 days or more		—		—		—		2		—		2		—		4		N/M			—		4
Accruing loans past due 30 through 89 days	$	—		—		—		—		—		—		—		—		N/M			—		—


West –		Alaska, California, Hawaii, Idaho, Montana, Oregon, Washington, and Wyoming
Southwest –		Arizona, Nevada, and New Mexico
Central –		Arkansas, Colorado, Oklahoma, Texas, and Utah
Midwest –		Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, and Wisconsin
Southeast –		Alabama, Delaware, Florida, Georgia, Kentucky, Louisiana, Maryland, Mississippi, North Carolina, South Carolina, Tennessee, Virginia, Washington D.C., and West Virginia
Northeast –		Connecticut, Maine, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont
National –		Accounts in three or more regions

During the first six months of 2016, nonperforming loans related to nonowner-occupied properties increased by $10 million from December 31, 2015, to $26 million at June 30, 2016, and increased by $10 million when compared to June 30, 2015. Our nonowner-occupied commercial real estate portfolio has increased by 7.8%, or approximately $508 million, since June 30, 2015, as many of our clients have taken advantage of opportunities to permanently refinance their loans at historically low interest rates.

Commercial lease financing. We conduct commercial lease financing arrangements through our KEF line of business and have both the scale and array of products to compete in the equipment lease financing business. Commercial lease financing receivables represented 9% of commercial loans at both June 30, 2016, and June 30, 2015.

Commercial loan modification and restructuring

We modify and extend certain commercial loans in the normal course of business for our clients. Loan modifications vary and are handled on a case-by-case basis with strategies responsive to the specific circumstances of each loan and borrower. In many cases, borrowers have other resources and can reinforce the credit with additional capital, collateral, guarantees, or other income sources.

Modifications are negotiated to achieve mutually agreeable terms that maximize loan credit quality while at the same time meeting our clients’ financing needs. Modifications made to loans of creditworthy borrowers not experiencing financial difficulties and under circumstances where ultimate collection of all principal and interest is not in doubt are not classified as TDRs. In accordance with applicable accounting guidance, a loan is classified as a TDR only when the borrower is experiencing financial difficulties and a creditor concession has been granted.

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Our concession types are primarily interest rate reductions, forgiveness of principal, and other modifications. Loan extensions are sometimes coupled with these primary concession types. Because economic conditions have improved modestly and we have restructured loans to provide the optimal opportunity for successful repayment by the borrower, certain of our restructured loans have returned to accrual status and consistently performed under the restructured loan terms over the past year.

If loan terms are extended at less than normal market rates for similar lending arrangements, our Asset Recovery Group is consulted to help determine if any concession granted would result in designation as a TDR. Transfer to our Asset Recovery Group is considered for any commercial loan determined to be a TDR. During the first six months of 2016, we had $7 million of new restructured commercial loans compared to $48 million new restructured commercial loans during the first six months of 2015.

For more information on concession types for our commercial accruing and nonaccruing TDRs, see Note 4 (“Asset Quality”).

Figure 21. Commercial TDRs by Accrual Status


in millions	June 30, 2016		March 31, 2016		December 31, 2015		September 30, 2015		June 30, 2015
Commercial TDRs by Accrual Status
Nonaccruing	$	33	$	50	$	52	$	57	$	66
Accruing		20		2		2		4		4

Total Commercial TDRs	$	53	$	52	$	54	$	61	$	70

We often use an A-B note structure for our TDRs, breaking the existing loan into two tranches. First, we create an A note. Since the objective of this TDR note structure is to achieve a fully performing and well-rated A note, we focus on sizing that note to a level that is supported by cash flow available to service debt at current market terms and consistent with our customary underwriting standards. This note structure typically will include a debt coverage ratio of 1.2 or better of cash flow to monthly payments of market interest, and principal amortization of generally not more than 25 years. These metrics are adjusted from time to time based upon changes in long-term markets and “take-out underwriting standards” of our various lines of business. Appropriately sized A notes are more likely to return to accrual status, allowing us to resume recognizing interest income. As the borrower’s payment performance improves, these restructured notes typically also allow for an upgraded internal quality risk rating classification.

The B note typically is a structurally subordinate note that may or may not require any debt service until the primary payment source stabilizes and generates excess cash flow. This excess cash flow customarily is captured for application to either the A note or B note dependent upon the terms of the restructure. We evaluate the B note when we consider returning the A note to accrual status. In many cases, the B note is charged off at the same time the A note is returned to accrual status in accordance with our interpretation of accounting and regulatory guidance applicable to TDRs. Alternatively, both A and B notes may be simultaneously returned to accrual if credit metrics are supportive.

Restructured nonaccrual loans may be returned to accrual status based on a current, well-documented evaluation of the credit, which would include analysis of the borrower’s financial condition, prospects for repayment under the modified terms, and alternate sources of repayment such as the value of loan collateral. We consider the borrower’s ability to perform under the modified terms for a reasonable period (generally a minimum of six months) before returning the loan to accrual status. Sustained historical repayment performance prior to the restructuring also may be taken into account. The primary consideration for returning a restructured loan to accrual status is the reasonable assurance that the full contractual principal balance of the loan and the ongoing contractually required interest payments will be fully repaid. Although our policy is a guideline, considerable judgment is required to review each borrower’s circumstances.

All loans processed as TDRs, including A notes and any non-charged-off B notes, are reported as TDRs during the calendar year in which the restructure took place. At June 30, 2016, we had $52 million and $2 million of A note and B note commercial TDRs, respectively.

Additional information regarding TDRs is provided in Note 4 (“Asset Quality”).

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Extensions. Project loans typically are refinanced into the permanent commercial loan market at maturity, but they are often modified and extended. Extension terms take into account the specific circumstances of the client relationship, the status of the project, and near-term prospects for the client, the repayment source, and the collateral. In all cases, pricing and loan structure are reviewed and, where necessary, modified to ensure the loan has been priced to achieve a market rate of return and loan terms that are appropriate for the risk. Typical enhancements include one or more of the following: principal pay down, increased amortization, additional collateral, increased guarantees, and a cash flow sweep. Some maturing loans have automatic extension options built in; in those cases, pricing and loan terms cannot be altered.

Loan pricing is determined based on the strength of the borrowing entity, the strength of the guarantor, if any, and the structure and residual risk of the transaction. Therefore, pricing for an extended loan may remain the same because the loan is already priced at or above current market.

We do not consider loan extensions in the normal course of business (under existing loan terms or at market rates) as TDRs, particularly when ultimate collection of all principal and interest is not in doubt and no concession has been made. In the case of loan extensions where either collection of all principal and interest is uncertain or a concession has been made, we would analyze such credit under the applicable accounting guidance to determine whether it qualifies as a TDR. Extensions that qualify as TDRs are measured for impairment under the applicable accounting guidance.

Guarantors. We conduct a detailed guarantor analysis (1) for all new extensions of credit, (2) at the time of any material modification/extension, and (3) typically annually, as part of our on-going portfolio and loan monitoring procedures. This analysis requires the guarantor entity to submit all appropriate financial statements, including balance sheets, income statements, tax returns, and real estate schedules.

While the specific steps of each guarantor analysis may vary, the high-level objectives include determining the overall financial conditions of the guarantor entities, including size, quality, and nature of asset base; net worth (adjusted to reflect our opinion of market value); leverage; standing liquidity; recurring cash flow; contingent and direct debt obligations; and near-term debt maturities.

Borrower and guarantor financial statements are required at least annually within 90-120 days of the calendar/fiscal year end. Income statements and rent rolls for project collateral are required quarterly. We may require certain information, such as liquidity, certifications, status of asset sales or debt resolutions, and real estate schedules, to be provided more frequently.

We routinely seek performance from guarantors of impaired debt if the guarantor is solvent. We may not seek to enforce the guaranty if we are precluded by bankruptcy or we determine the cost to pursue a guarantor exceeds the value to be returned given the guarantor’s verified financial condition. We often are successful in obtaining either monetary payment or the cooperation of our solvent guarantors to help mitigate loss, cost, and the expense of collections.

Mortgage and construction loans with a loan-to-value ratio greater than 1.0 are accounted for as performing loans. These loans were not considered impaired due to one or more of the following factors: (i) underlying cash flow adequate to service the debt at a market rate of return with adequate amortization; (ii) a satisfactory borrower payment history; and (iii) acceptable guarantor support. As of June 30, 2016, we did not have any mortgage and construction loans that had a loan-to-value ratio greater than 1.0.

Consumer loan portfolio

Consumer loans outstanding decreased by $570 million, or 4%, from one year ago. The home equity portfolio is the largest segment of our consumer loan portfolio. Approximately 98% of this portfolio at June 30, 2016, was originated from our Key Community Bank within our 12-state footprint. The remainder of the portfolio, which has been in an exit mode since the fourth quarter of 2007, was originated from the Consumer Finance line of business and is now included in Other Segments. Home equity loans in Key Community Bank decreased by $417 million, or 4%, over the past twelve months.

As shown in Figure 17, we held the first lien position for approximately 61% of the Key Community Bank home equity portfolio at June 30, 2016, and 60% at June 30, 2015. For consumer loans with real estate collateral, we track borrower performance monthly. Regardless of the lien position, credit metrics are refreshed quarterly, including recent Fair Isaac Corporation scores as well as original and updated loan-to-value ratios. This information is used in establishing the ALLL. Our methodology is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses” beginning on page 122 of our 2015 Form 10-K.

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At June 30, 2016, 39% of our home equity portfolio was secured by second lien mortgages. On at least a quarterly basis, we continue to monitor the risk characteristics of these loans when determining whether our loss estimation methods are appropriate.

Figure 22 summarizes our home equity loan portfolio at the end of each of the last five quarters, as well as certain asset quality statistics and yields on the portfolio as a whole.

Figure 22. Home Equity Loans


	2016						2015
dollars in millions	Second			First			Fourth			Third			Second
Home Equity Loans	$	10,062		$	10,149		$	10,335		$	10,504		$	10,532

Nonperforming loans at period end	$	189		$	191		$	190		$	181		$	184
Net loan charge-offs for the period		3			7			5			3			8
Yield for the period		4.04	%		4.06	%		3.97	%		3.96	%		3.98	%

Loans held for sale

As shown in Note 3 (“Loans and Loans Held for Sale”), our loans held for sale decreased to $442 million at June 30, 2016, from $639 million at December 31, 2015, and from $835 million at June 30, 2015.

At June 30, 2016, loans held for sale included $150 million of commercial, financial and agricultural loans, which decreased $67 million from June 30, 2015, $270 million of commercial mortgage loans, which decreased $306 million from June 30, 2015, $19 million of residential mortgage loans, which decreased $16 million from June 30, 2015, and $3 million of commercial lease financing loans, which decreased $4 million from June 30, 2015.

Loan sales

As shown in Figure 23, during the first six months of 2016, we sold $2.4 billion of commercial real estate loans, $200 million of residential real estate loans, $209 million of commercial lease financing loans, and $129 million of commercial loans. Most of these sales came from the held-for-sale portfolio; however, $72 million of these loan sales related to the held-to-maturity portfolio.

Loan sales classified as held for sale generated net gains of $31 million in the first six months of 2016 and are included in “investment banking and debt placement fees” and “other income” on the income statement.

Among the factors that we consider in determining which loans to sell are:

•

our business strategy for particular lending areas;

•

whether particular lending businesses meet established performance standards or fit with our relationship banking strategy;

•

our A/LM needs;

•

the cost of alternative funding sources;

•

the level of credit risk;

•

capital requirements; and

•

market conditions and pricing.

Figure 23 summarizes our loan sales for the first six months of 2016 and all of 2015.

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Figure 23. Loans Sold (Including Loans Held for Sale)


in millions	Commercial		Commercial Real Estate		Commercial Lease Financing		Residential Real Estate		Total
2016
Second quarter	$	83	$	1,518	$	121	$	111	$	1,833
First quarter		46		925		88		89		1,148

Total	$	129	$	2,443	$	209	$	200	$	2,981

2015
Fourth quarter	$	86	$	1,570	$	204	$	104	$	1,964
Third quarter		150		1,246		100		142		1,638
Second quarter		41		2,210		48		188		2,487
First quarter		58		1,010		63		120		1,251

Total	$	335	$	6,036	$	415	$	554	$	7,340

Figure 24 shows loans that are either administered or serviced by us, but not recorded on the balance sheet, and includes loans that were sold.

Figure 24. Loans Administered or Serviced


in millions	June 30, 2016		March 31, 2016		December 31, 2015		September 30, 2015		June 30, 2015
Commercial real estate loans	$	213,879	$	214,756	$	211,274	$	206,893	$	203,315
Education loans		1,226		1,280		1,339		1,398		1,459
Commercial lease financing		930		891		932		779		709
Commercial loans		355		347		335		340		337

Total	$	216,390	$	217,274	$	213,880	$	209,410	$	205,820

In the event of default by a borrower, we are subject to recourse with respect to approximately $2 billion of the $216 billion of loans administered or serviced at June 30, 2016. Additional information about this recourse arrangement is included in Note 15 (“Contingent Liabilities and Guarantees”) under the heading “Recourse agreement with FNMA.”

We derive income from several sources when retaining the right to administer or service loans that are sold. We earn noninterest income (recorded as “mortgage servicing fees”) from fees for servicing or administering loans. This fee income is reduced by the amortization of related servicing assets. In addition, we earn interest income from investing funds generated by escrow deposits collected in connection with the servicing of commercial real estate loans.

Securities

Our securities portfolio totaled $19.4 billion at June 30, 2016, compared to $19.1 billion at December 31, 2015, and $19.3 billion at June 30, 2015. Available-for-sale securities were $14.6 billion at June 30, 2016, compared to $14.2 billion at December 31, 2015, and $14.3 billion at June 30, 2015. Held-to-maturity securities were $4.8 billion at June 30, 2016, compared to $4.9 billion at December 31, 2015, and $5 billion at June 30, 2015.

As shown in Figure 25, all of our mortgage-backed securities, which include both securities available for sale and held-to-maturity securities, are issued by government-sponsored enterprises or GNMA and traded in liquid secondary markets. These securities are recorded on the balance sheet at fair value for the available-for-sale portfolio and at cost for the held-to-maturity portfolio. For more information about these securities, see Note 5 (“Fair Value Measurements”) under the heading “Qualitative Disclosures of Valuation Techniques,” and Note 6 (“Securities”).

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Figure 25. Mortgage-Backed Securities by Issuer


in millions	June 30, 2016		December 31, 2015		June 30, 2015
FHLMC	$	4,001	$	4,349	$	5,037
FNMA		5,330		4,511		5,085
GNMA		9,999		10,152		9,083

Total^(a)	$	19,330	$	19,012	$	19,205

(a)	Includes securities held in the available-for-sale and held-to-maturity portfolios.

Securities available for sale

The majority of our securities available-for-sale portfolio consists of Federal Agency CMOs and mortgage-backed securities. CMOs are debt securities secured by a pool of mortgages or mortgage-backed securities. These mortgage securities generate interest income, serve as collateral to support certain pledging agreements, and provide liquidity value under regulatory requirements. At June 30, 2016, we had $14.5 billion invested in CMOs and other mortgage-backed securities in the available-for-sale portfolio, compared to $14.2 billion at December 31, 2015, and $14.2 billion at June 30, 2015.

We periodically evaluate our securities available-for-sale portfolio in light of established A/LM objectives, changing market conditions that could affect the profitability of the portfolio, the regulatory environment, and the level of interest rate risk to which we are exposed. These evaluations may cause us to take steps to adjust our overall balance sheet positioning.

In addition, the size and composition of our securities available-for-sale portfolio could vary with our needs for liquidity and the extent to which we are required (or elect) to hold these assets as collateral to secure public funds and trust deposits. Although we generally use debt securities for this purpose, other assets, such as securities purchased under resale agreements or letters of credit, are used occasionally when they provide a lower cost of collateral or more favorable risk profiles.

Our investing activities continue to complement other balance sheet developments and provide for our ongoing liquidity management needs. Our actions to not reinvest the monthly security cash flows at various times provide the liquidity necessary to address our funding requirements. These funding requirements include ongoing loan growth and occasional debt maturities. At other times, we may make additional investments that go beyond the replacement of maturities or mortgage security cash flows as our liquidity position and/or interest rate risk management strategies may require. Lastly, our focus on investing in high quality liquid assets, including GNMA-related securities, is related to liquidity management strategies to satisfy regulatory requirements.

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Figure 26 shows the composition, yields, and remaining maturities of our securities available for sale. For more information about these securities, including gross unrealized gains and losses by type of security and securities pledged, see Note 6.

Figure 26. Securities Available for Sale


dollars in millions	States and Political Subdivisions			Collateralized Mortgage Obligations ^(a)			Other Mortgage- Backed Securities ^(a)			Other Securities ^(b)		Total			Weighted- Average Yield ^(c)
June 30, 2016
Remaining maturity:
One year or less	$	1		$	239		$	12			—	$	252			3.13	%
After one through five years		11			12,279			1,346		$	13		13,649			2.09
After five through ten years		—			—			642			7		649			2.12
After ten years		—			—			2			—		2			5.59

Fair value	$	12		$	12,518		$	2,002		$	20	$	14,552			—
Amortized cost		11			12,344			1,970			21		14,346			2.11	%
Weighted-average yield ^(c)		6.22	%		2.09	%		2.22	%		—		2.11	%^(d)		—
Weighted-average maturity		2.9 years			3.5 years			4.2 years			3.9 years		3.6 years			—

December 31, 2015
Fair value	$	14		$	11,995		$	2,189		$	20	$	14,218			—
Amortized cost		14			12,082			2,193			21		14,310			2.14	%

June 30, 2015
Fair value	$	19		$	11,751		$	2,452		$	22	$	14,244			—
Amortized cost		19			11,765			2,439			20		14,243			2.13	%

(a)	Maturity is based upon expected average lives rather than contractual terms.

(b)	Includes primarily marketable equity securities.

(c)	Weighted-average yields are calculated based on amortized cost. Such yields have been adjusted to a taxable-equivalent basis using the statutory federal income tax rate of 35%.

(d)	Excludes $20 million of securities at June 30, 2016, that have no stated yield.

Held-to-maturity securities

Federal Agency CMOs and mortgage-backed securities constitute essentially all of our held-to-maturity securities. The remaining balance comprises foreign bonds and capital securities. Figure 27 shows the composition, yields, and remaining maturities of these securities.

Figure 27. Held-to-Maturity Securities


dollars in millions	Collateralized Mortgage Obligations			Other Mortgage-backed Securities			Other Securities			Total			Weighted- Average Yield ^(a)
June 30, 2016
Remaining maturity:
One year or less	$	77			—		$	9		$	86			2.41	%
After one through five years		4,022			—			13			4,035			1.90
After five through ten years		—		$	711			—			711			2.70
After ten years		—			—			—			—			—

Amortized cost	$	4,099		$	711		$	22		$	4,832			2.03	%
Fair value		4,138			729			22			4,889			—
Weighted-average yield		1.91	%		2.70	%		2.61	%^(b)		2.03	%^(b)		—
Weighted-average maturity		3.1 years			7.5 years			1.7 years			3.7 years			—

December 31, 2015
Amortized cost	$	4,174		$	703		$	20		$	4,897			2.01	%
Fair value		4,129			699			20			4,848			—

June 30, 2015
Amortized cost	$	4,463		$	539		$	20		$	5,022			1.97	%
Fair value		4,437			535			20			4,992			—

(a)	Weighted-average yields are calculated based on amortized cost. Such yields have been adjusted to a taxable-equivalent basis using the statutory federal income tax rate of 35%.

(b)	Excludes $5 million of securities at June 30, 2016, that have no stated yield.

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Other investments

Principal investments — investments in equity and debt instruments made by our Principal Investing unit — represented 39%, 46%, and 50% of other investments at June 30, 2016, December 31, 2015, and June 30, 2015, respectively. They include direct investments (investments made in a particular company) as well as indirect investments (investments made through funds that include other investors). Principal investments are predominantly made in privately held companies and are carried at fair value. The fair value of the direct investments was $40 million at June 30, 2016, $69 million at December 31, 2015, and $70 million at June 30, 2015, while the fair value of the indirect investments was $184 million at June 30, 2016, $235 million at December 31, 2015, and $282 million at June 30, 2015. Under the requirements of the Volcker Rule, we will be required to dispose of some or all of our indirect principal investments. The Federal Reserve extended the conformance period to July 21, 2017, for all banking entities with respect to covered funds. Key is permitted to file for an additional extension of up to five years for illiquid funds, to retain the indirect investments for a longer period of time. We plan to continue to evaluate our options, including applying for the extension and holding the investments. Additional information about this investment is provided in the “Principal investments” section of Note 5 (“Fair Value Measurements”). For more information about the Volcker Rule, see the discussion in Item 1 under the heading “Other Regulatory Developments under the Dodd-Frank Act — ‘Volcker Rule’” in the section entitled “Supervision and Regulation” beginning on page 17 of our 2015 Form 10-K.

In addition to principal investments, “other investments” include other equity and mezzanine instruments, such as certain real-estate-related investments and an indirect ownership interest in a partnership, that are carried at fair value, as well as other types of investments that generally are carried at cost. The real-estate-related investments were valued at $8 million at June 30, 2016 and December 31, 2015, and $9 million at June 30, 2015. The indirect investment in a partnership was valued at $4 million at June 30, 2015. Under the requirements of the Volcker Rule, we were required to dispose of this investment, which was redeemed prior to December 31, 2015. Additional information pertaining to the equity investment is included in the “Assets and Liabilities Measured at Fair Value on a Recurring Basis” section of Note 5.

Most of our other investments are not traded on an active market. We determine the fair value at which these investments should be recorded based on the nature of the specific investment and all available relevant information. This review may encompass such factors as the issuer’s past financial performance and future potential, the values of public companies in comparable businesses, the risks associated with the particular business or investment type, current market conditions, the nature and duration of resale restrictions, the issuer’s payment history, our knowledge of the industry, third-party data, and other relevant factors. During the first six months of 2016, net gains from our principal investing activities (including results attributable to noncontrolling interests) totaled $11 million, which includes $45 million of net unrealized losses. These net losses are recorded as “net gains (losses) from principal investing” on the income statement. Additional information regarding these investments is provided in Note 5.

Deposits and other sources of funds

Domestic deposits are our primary source of funding. The composition of our average deposits is shown in Figure 8 in the section entitled “Net interest income.” During the second quarter of 2016, average domestic deposits were $73.9 billion and represented 84% of the funds we used to support loans and other earning assets, compared to $70.3 billion and 85% during the second quarter of 2015. Interest-bearing deposits increased $4.9 billion driven by a $3.6 billion increase in NOW and money market deposit accounts and a $1.3 billion increase in certificates of deposit and other time deposits. The increase in average deposits from the year-ago quarter reflects core deposit growth in our retail banking franchise, growth in escrow deposits from the commercial mortgage servicing business, and commercial deposit inflows. These increases were partially offset by a $1.2 billion decline in noninterest-bearing deposits.

Wholesale funds, consisting of deposits in our foreign office and short-term borrowings, averaged $1 billion during the second quarter of 2016, compared to $1.8 billion during the second quarter of 2015. The change from the second quarter of 2015 was caused by declines of $583 million in foreign office deposits and $220 million in federal funds purchased and securities sold under repurchase agreements, partially offset by an increase of $37 million in bank notes and other short-term borrowings.

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Capital

At June 30, 2016, our shareholders’ equity was $11.3 billion, up $567 million from December 31, 2015. The following sections discuss certain factors that contributed to this change. For other factors that contributed to the change, see the Consolidated Statements of Changes in Equity (Unaudited).

CCAR and capital actions

As part of its ongoing supervisory process, the Federal Reserve requires BHCs like KeyCorp to submit an annual comprehensive capital plan and to update that plan to reflect material changes in the BHC’s risk profile, business strategies, or corporate structure, including but not limited to changes in planned capital actions. The 2015 capital plan, which was effective through the second quarter of 2016, included a common share repurchase program of up to $725 million, which included repurchases to offset issuances of common shares under our employee compensation plans. Common share repurchases under the 2015 capital plan began in the second quarter of 2015 and were suspended in the fourth quarter of 2015 in connection with the announcement of our acquisition of First Niagara. In April 2016, we submitted to the Federal Reserve and provided to the OCC our 2016 capital plan under the annual CCAR process. On June 29, 2016, the Federal Reserve announced that it did not object to our 2016 capital plan. Share repurchases of up to $350 million were included in the 2016 capital plan, which is effective through the second quarter of 2017. We anticipate repurchasing common shares in the third quarter of 2016 following the completion of the acquisition of First Niagara.

Dividends

As previously reported, our 2015 capital plan proposed an increase in our quarterly common share dividend from $.075 to $.085 per share, which was approved by our Board in May 2016. An additional potential increase in our quarterly common share dividend, up to $.095 per share, will be considered by the Board for the second quarter of 2017, consistent with the 2016 capital plan. Further information regarding the capital planning process and CCAR is included under the heading “Regulatory capital and liquidity” in the “Supervision and Regulation” section beginning on page 10 of our 2015 Form 10-K.

Consistent with the 2015 capital plan, we made a dividend payment of $.085 per share, or $72 million, on our common shares during the second quarter of 2016.

We also made quarterly a dividend payment of $1.9375 per share, or $5.6 million, on our Series A Preferred Stock during the second quarter of 2016.

Common shares outstanding

Our common shares are traded on the NYSE under the symbol KEY with 26,501 holders of record at June 30, 2016. Our book value per common share was $13.08 based on 842.7 million shares outstanding at June 30, 2016, compared to $12.51 per common share based on 835.8 million shares outstanding at December 31, 2015, and $12.21 per common share based on 843.6 million shares outstanding at June 30, 2015. At June 30, 2016, our tangible book value per common share was $11.81, compared to $11.22 per common share at December 31, 2015, and $10.92 per common share at June 30, 2015.

Figure 28 shows activities that caused the change in outstanding common shares over the past five quarters.

Figure 28. Changes in Common Shares Outstanding


	2016				2015
in thousands	Second		First		Fourth		Third			Second
Shares outstanding at beginning of period		842,290		835,751		835,285		843,608			850,920
Common shares repurchased		—		—		—		(8,386	)		(8,794	)
Shares reissued (returned) under employee benefit plans		413		6,539		466		63			1,482

Shares outstanding at end of period		842,703		842,290		835,751		835,285			843,608

As shown above, common shares outstanding increased by .4 million shares during the second quarter of 2016 due to the net activity in our employee benefit plans.

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At June 30, 2016, we had 174.3 million treasury shares, compared to 181.2 million treasury shares at December 31, 2015, and 173.4 million treasury shares at June 30, 2015. Going forward we expect to reissue treasury shares as needed in connection with stock-based compensation awards and for other corporate purposes.

Information on repurchases of common shares by KeyCorp is included in Part II, Item 2. “Unregistered Sales of Equity Securities and Use of Proceeds” of this report.

Capital adequacy

Capital adequacy is an important indicator of financial stability and performance. All of our capital ratios remained in excess of regulatory requirements at June 30, 2016. Our capital and liquidity levels are intended to position us to weather an adverse credit cycle while continuing to serve our clients’ needs, as well as to meet the Regulatory Capital Rules described in the “Supervision and regulation” section of Item 2 of this report. Our shareholders’ equity to assets ratio was 11.18% at June 30, 2016, compared to 11.30% at December 31, 2015, and 11.19% at June 30, 2015. Our tangible common equity to tangible assets ratio was 9.95% at June 30, 2016, compared to 9.98% at December 31, 2015, and 9.86% at June 30, 2015.

Federal banking regulators have promulgated minimum risk-based capital and leverage ratio requirements for BHCs like KeyCorp and their banking subsidiaries like KeyBank. As of January 1, 2016, Key and KeyBank (consolidated) were each required to maintain a minimum Tier 1 risk-based capital ratio of 6.0%, a total risk-based capital ratio of 8.0%, and a Tier 1 leverage ratio of 4.0%. At June 30, 2016, our Tier 1 risk-based capital ratio, total risk-based capital ratio, and Tier 1 leverage ratio were 11.41%, 13.63%, and 10.59%, respectively, compared to 11.35%, 12.97%, and 10.72%, respectively, at December 31, 2015, and 11.11%, 12.66%, and 10.74%, respectively, at June 30, 2015. In addition, as of January 1, 2016, Key and KeyBank (consolidated) were each required to maintain a minimum Common Equity Tier 1 capital ratio of 4.5%. At June 30, 2016, our Common Equity Tier 1 capital ratio was 11.10%.

The adoption of the Regulatory Capital Rules changes the regulatory capital standards that apply to BHCs by phasing out the treatment of capital securities and cumulative preferred securities as eligible Tier 1 capital. The phase-out period, which began January 1, 2015, for standardized approach banking organizations such as KeyCorp, resulted in our trust preferred securities issued by the KeyCorp capital trusts being treated only as Tier 2 capital starting in 2016. The new minimum capital and leverage ratios under the Regulatory Capital Rules together with the estimated ratios of Key at June 30, 2016, calculated on a fully phased-in basis, are set forth under the heading “New minimum capital and leverage ratio requirements” in the “Supervision and regulation” section in Item 2 of this report.

As previously indicated in the “Supervision and Regulation” section of Item 1 of our 2015 Form 10-K under the heading “Revised prompt corrective action capital category ratios,” the prompt corrective action capital category regulations do not apply to BHCs. If, however, these regulations did apply to BHCs, we believe KeyCorp would qualify for the “well capitalized” capital category at June 30, 2016. The threshold ratios for a “well capitalized” and an “adequately capitalized” institution under the Regulatory Capital Rules are described in the “Supervision and Regulation” section of Item 1 of this report under the heading “Revised prompt corrective action capital category ratios.” Since the regulatory capital categories under these regulations serve a limited supervisory function, investors should not use them as a representation of the overall financial condition or prospects of KeyCorp. A discussion of the regulatory capital standards and other related capital adequacy regulatory standards is included in the section “Regulatory capital and liquidity” in “Supervision and Regulation” under Item 1 of our 2015 Form 10-K.

Traditionally, the banking regulators have assessed bank and BHC capital adequacy based on both the amount and composition of capital, the calculation of which is prescribed in federal banking regulations. The capital modifications mandated by the Regulatory Capital Rules, which became effective on January 1, 2015, for Key, require higher and better-quality capital and introduced a new capital measure, “Common Equity Tier 1.” Common Equity Tier 1 is not formally defined by GAAP and is considered to be a non-GAAP financial measure. Figure 7 in the “Highlights of Our Performance” section reconciles Key shareholders’ equity, the GAAP performance measure, to Common Equity Tier 1, the corresponding non-GAAP measure. Our Common Equity Tier 1 ratio was 11.10% at June 30, 2016.

At June 30, 2016, for Key’s consolidated operations, we had a federal net deferred tax asset of $91 million and a state deferred tax asset of $13 million, compared to a federal net deferred tax asset of $210 million and a state deferred tax asset of $25 million at June 30, 2015. We had a valuation allowance against the gross deferred tax assets associated with certain state net operating loss carryforwards and state credit carryforwards of less than $1 million at June 30, 2016, and June 30, 2015. Starting with the implementation of the Regulatory Capital Rules on January 1, 2015, deferred tax assets that arise from net

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operating loss and tax credit carryforwards are deductible from Common Equity Tier 1 on a phase-in basis. As of June 30, 2016, this balance was $1 million.

Figure 29 represents the details of our regulatory capital position at June 30, 2016, December 31, 2015, and June 30, 2015, under the Regulatory Capital Rules.

Figure 29. Capital Components and Risk-Weighted Assets (Regulatory Capital Rules)


dollars in millions	June 30, 2016			December 31, 2015			June 30, 2015
COMMON EQUITY TIER 1
Key shareholders’ equity (GAAP)	$	11,313		$	10,746		$	10,590
Less: Series A Preferred Stock ^(a)		281			281			281

Common Equity Tier 1 capital before adjustments and deductions		11,032			10,465			10,309

Less: Goodwill, net of deferred taxes		1,031			1,034			1,034
Intangible assets, net of deferred taxes		30			26			33
Deferred tax assets		1			1			1
Net unrealized gains (losses) on available-for-sale securities, net of deferred taxes		129			(58	)		—
Accumulated gains (losses) on cash flow hedges, net of deferred taxes		77			(20	)		(20	)
Amounts in AOCI attributed to pension and postretirement benefit costs, net of deferred taxes		(362	)		(365	)		(361	)

Total Common Equity Tier 1 capital	$	10,126		$	9,847		$	9,622

TIER 1 CAPITAL
Common Equity Tier 1	$	10,126		$	9,847		$	9,622
Additional Tier 1 capital instruments and related surplus		281			281			281
Non-qualifying capital instruments subject to phase out		—			85			85
Less: Deductions		1			1			1

Total Tier 1 capital		10,406			10,212			9,987

TIER 2 CAPITAL
Tier 2 capital instruments and related surplus		1,101			578			521
Allowance for losses on loans and liability for losses on lending-related commitments ^(b)		925			881			863
Net unrealized gains on available-for-sale preferred stock classified as an equity security		—			—			1
Less: Deductions		—			—			—

Total Tier 2 capital		2,026			1,459			1,385

Total risk-based capital	$	12,432		$	11,671		$	11,372

RISK-WEIGHTED ASSETS
Risk-weighted assets on balance sheet	$	68,981		$	67,390		$	67,460
Risk-weighted off-balance sheet exposure		21,499			21,983			21,808
Market risk-equivalent assets		715			607			583

Gross risk-weighted assets		91,195			89,980			89,851
Less: Excess allowance for loan and lease losses		—			—			—

Net risk-weighted assets	$	91,195		$	89,980		$	89,851

AVERAGE QUARTERLY TOTAL ASSETS	$	98,290		$	95,272		$	93,024

CAPITAL RATIOS
Tier 1 risk-based capital		11.41	%		11.35	%		11.11	%
Total risk-based capital		13.63			12.97			12.66
Leverage ^(c)		10.59			10.72			10.74
Common Equity Tier 1		11.10			10.94			10.71

(a)	Net of capital surplus.

(b)

The ALLL included in Tier 2 capital is limited by regulation to 1.25% of the institution’s standardized total risk-weighted assets (excluding its standardized market risk-weighted assets). The ALLL includes $20 million, $28 million, and $22 million of allowance classified as “discontinued assets” on the balance sheet at June 30, 2016, December 31, 2015, and June 30, 2015, respectively.

(c)	This ratio is Tier 1 capital divided by average quarterly total assets as defined by the Federal Reserve less: (i) goodwill, (ii) the disallowed intangible and deferred tax assets, and (iii) other deductions from assets for leverage capital purposes.

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Risk Management

Overview

Like all financial services companies, we engage in business activities and assume the related risks. The most significant risks we face are credit, compliance, operational, liquidity, market, reputation, strategic, and model risks. Our risk management activities are focused on ensuring we properly identify, measure, and manage such risks across the entire enterprise to maintain safety and soundness and maximize profitability. Certain of these risks are defined and discussed in greater detail in the remainder of this section.

The Board serves in an oversight capacity ensuring that Key’s risks are managed in a manner that is effective and balanced and adds value for the shareholders. The Board understands Key’s risk philosophy, approves the risk appetite, inquires about risk practices, reviews the portfolio of risks, compares the actual risks to the risk appetite, and is apprised of significant risks, both actual and emerging, and determines whether management is responding appropriately. The Board challenges management and ensures accountability.

The Board’s Audit Committee assists the Board in oversight of financial statement integrity, regulatory and legal requirements, independent auditors’ qualifications and independence, and the performance of the internal audit function and independent auditors. The Audit Committee meets with management and approves significant policies relating to the risk areas overseen by the Audit Committee. The Audit Committee has responsibility over all risk review functions, including internal audit, as well as financial reporting, legal matters, and fraud risk. The Audit Committee also receives reports on enterprise risk. In addition to regularly scheduled bi-monthly meetings, the Audit Committee convenes to discuss the content of our financial disclosures and quarterly earnings releases.

The Board’s Risk Committee assists the Board in oversight of strategies, policies, procedures, and practices relating to the assessment and management of enterprise-wide risk, including credit, market, liquidity, model, operational, compliance, reputation, and strategic risks. The Risk Committee also assists the Board in overseeing risks related to capital adequacy, capital planning, and capital actions. The Risk Committee reviews and provides oversight of management’s activities related to the enterprise-wide risk management framework, which includes review of the ERM Policy, including the Risk Appetite Statement, and management and ERM reports. The Risk Committee also approves any material changes to the charter of the ERM Committee and significant policies relating to risk management.

The Audit and Risk Committees meet jointly, as appropriate, to discuss matters that relate to each committee’s responsibilities. Committee chairpersons routinely meet with management during interim months to plan agendas for upcoming meetings and to discuss emerging trends and events that have transpired since the preceding meeting. All members of the Board receive formal reports designed to keep them abreast of significant developments during the interim months.

Our ERM Committee, chaired by the Chief Executive Officer and comprising other senior level executives, is responsible for managing risk and ensuring that the corporate risk profile is managed in a manner consistent with our risk appetite. The ERM Program encompasses our risk philosophy, policy, framework, and governance structure for the management of risks across the entire company. The ERM Committee reports to the Board’s Risk Committee. Annually, the Board reviews and approves the ERM Policy, as well as the risk appetite, including corporate risk tolerances for major risk categories. We use a risk-adjusted capital framework to manage risks. This framework is approved and managed by the ERM Committee.

Tier 2 Risk Governance Committees support the ERM Committee by identifying early warning events and trends, escalating emerging risks, and discussing forward-looking assessments. Risk Governance Committees include attendees from each of the Three Lines of Defense. The First Line of Defense is the Line of Business primarily responsible to accept, own, proactively identify, monitor, and manage risk. The Second Line of Defense comprises Risk Management representatives who provide independent, centralized oversight over all risk categories by aggregating, analyzing, and reporting risk information. Risk Review, our internal audit function, provides the Third Line of Defense in their role to provide independent assessment and testing of the effectiveness, appropriateness, and adherence to KeyCorp’s risk management policies, practices, and controls.

The Chief Risk Officer ensures that relevant risk information is properly integrated into strategic and business decisions, ensures appropriate ownership of risks, provides input into performance and compensation decisions, assesses aggregate enterprise risk, monitors capabilities to manage critical risks, and executes appropriate Board and stakeholder reporting.

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Federal banking regulators continue to emphasize with financial institutions the importance of relating capital management strategy to the level of risk at each institution. We believe our internal risk management processes help us achieve and maintain capital levels that are commensurate with our business activities and risks and conform to regulatory expectations.

Market risk management

Market risk is the risk that movements in market risk factors, including interest rates, foreign exchange rates, equity prices, commodity prices, credit spreads, and volatilities will reduce Key’s income and the value of its portfolios. These factors influence prospective yields, values, or prices associated with the instrument. For example, the value of a fixed-rate bond will decline when market interest rates increase, while the cash flows associated with a variable rate loan will increase when interest rates increase. The holder of a financial instrument is exposed to market risk when either the cash flows or the value of the instrument is tied to such external factors.

We are exposed to market risk both in our trading and nontrading activities, which include asset and liability management activities. Our trading positions are carried at fair value with changes recorded in the income statement. These positions are subject to various market-based risk factors that impact the fair value of the financial instruments in the trading category. Our traditional banking loan and deposit products as well as long-term debt and certain short-term borrowings are nontrading positions. These positions are generally carried at the principal amount outstanding for assets and the amount owed for liabilities. The nontrading positions are subject to changes in economic value due to varying market conditions, primarily changes in interest rates.

Trading market risk

Key incurs market risk as a result of trading, investing, and client facilitation activities, principally within our investment banking and capital markets businesses. Key has exposures to a wide range of interest rates, equity prices, foreign exchange rates, credit spreads, and commodity prices, as well as the associated implied volatilities and spreads. Our primary market risk exposures are a result of trading activities in the derivative and fixed income markets and maintaining positions in these instruments. We maintain modest trading inventories to facilitate customer flow, make markets in securities, and hedge certain risks. The majority of our positions are traded in active markets.

Management of trading market risks. Market risk management is an integral part of Key’s risk culture. The Risk Committee of our Board provides oversight of trading market risks. The ERM Committee and the Market Risk Committee regularly review and discuss market risk reports prepared by our MRM that contain our market risk exposures and results of monitoring activities. Market risk policies and procedures have been defined and approved by the Market Risk Committee, a Tier 2 Risk Governance Committee, and take into account our tolerance for risk and consideration for the business environment.

The MRM is an independent risk management function that partners with the lines of business to identify, measure, and monitor market risks throughout our company. The MRM is responsible for ensuring transparency of significant market risks, monitoring compliance with established limits, and escalating limit exceptions to appropriate senior management. The various business units and trading desks are responsible for ensuring that market risk exposures are well-managed and prudent. Market risk is monitored through various measures, such as VaR, and through routine stress testing, sensitivity, and scenario analyses. The MRM conducts stress tests for each covered position using historical worst case and standard shock scenarios. VaR, stressed VaR, and other analyses are prepared daily and distributed to appropriate management.

Covered positions. We monitor the market risk of our covered positions, which includes all of our trading positions as well as all foreign exchange and commodity positions, regardless of whether the position is in a trading account. All positions in the trading account are recorded at fair value, and changes in fair value are reflected in our consolidated statements of income. Information regarding our fair value policies, procedures, and methodologies is provided in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Fair Value Measurements” on page 124 of our 2015 Form 10-K and Note 5 (“Fair Value Measurements”) in this report. Instruments that are used to hedge nontrading activities, such as bank-issued debt and loan portfolios, equity positions that are not actively traded, and securities financing activities, do not meet the definition of a covered position. The MRM is responsible for identifying our portfolios as either covered or non-covered. The Covered Position Working Group develops the final list of covered positions, and a summary is provided to the Market Risk Committee.

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Our significant portfolios of covered positions are detailed below. We analyze market risk by portfolios of covered positions, and do not separately measure and monitor our portfolios by risk type. The descriptions below incorporate the respective risk types associated with each of these portfolios.

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Fixed income includes those instruments associated with our capital markets business and the trading of securities as a dealer. These instruments may include positions in municipal bonds, bonds backed by the U.S. government, agency and corporate bonds, certain mortgage-backed securities, securities issued by the U.S. Treasury, money markets, and certain CMOs. The activities and instruments within the fixed income portfolio create exposures to interest rate and credit spread risks.

•

Interest rate derivatives include interest rate swaps, caps, and floors, which are transacted primarily to accommodate the needs of commercial loan clients. In addition, we enter into interest rate derivatives to offset or mitigate the interest rate risk related to the client positions. The activities within this portfolio create exposures to interest rate risk.

•

Credit derivatives generally include credit default swap indexes, which are used to manage the credit risk exposure associated with anticipated sales of certain commercial real estate loans. The transactions within the credit derivatives portfolio result in exposure to counterparty credit risk and market risk.

VaR and stressed VaR. VaR is the estimate of the maximum amount of loss on an instrument or portfolio due to adverse market conditions during a given time interval within a stated confidence level. Stressed VaR is used to assess extreme conditions on market risk within our trading portfolios. MRM calculates VaR and stressed VaR on a daily basis, and the results are distributed to appropriate management. VaR and stressed VaR results are also provided to our regulators and utilized in regulatory capital calculations.

We use a historical VaR model to measure the potential adverse effect of changes in interest rates, foreign exchange rates, equity prices, and credit spreads on the fair value of our covered positions. Historical scenarios are customized for specific covered positions, and numerous risk factors are incorporated in the calculation. Additional consideration is given to the risk factors to estimate the exposures that contain optionality features, such as options and cancelable provisions. VaR is calculated using daily observations over a one-year time horizon, and approximates a 95% confidence level. Statistically, this means that we would expect to incur losses greater than VaR, on average, five out of 100 trading days, or three to four times each quarter. We also calculate VaR and stressed VaR at a 99% confidence level.

The VaR model is an effective tool in estimating ranges of possible gains and losses on our covered positions. However, there are limitations inherent in the VaR model since it uses historical results over a given time interval to estimate future performance. Historical results may not be indicative of future results, and changes in the market or composition of our portfolios could have a significant impact on the accuracy of the VaR model. We regularly review and enhance the modeling techniques, inputs and assumptions used. Our market risk policy includes the independent validation of our VaR model by Key’s Risk Management Group on an annual basis. The Model Risk Management Committee oversees the Model Validation Program, and results of validations are discussed with the ERM Committee.

Actual losses for the total covered positions did not exceed aggregate daily VaR on any day during the quarters ended June 30, 2016, and June 30, 2015. The MRM backtests our VaR model on a daily basis to evaluate its predictive power. The test compares VaR model results at the 99% confidence level to daily held profit and loss. Results of backtesting are provided to the Market Risk Committee. Backtesting exceptions occur when trading losses exceed VaR.

We do not engage in correlation trading, or utilize the internal model approach for measuring default and credit migration risk. Our net VaR approach incorporates diversification, but our VaR calculation does not include the impact of counterparty risk and our own credit spreads on derivatives.

The aggregate VaR at the 99% confidence level for all covered positions was $.8 million at June 30, 2016, and $1 million at June 30, 2015. The decrease in aggregate VaR was primarily due to the decreased exposure in our fixed income and equity portfolios. Figure 31 summarizes our VaR at the 99% confidence level for significant portfolios of covered positions for the three months ended June 30, 2016, and June 30, 2015. During these periods, none of our significant portfolios daily trading VaR numbers exceeded their VaR limits or stress VaR limits.

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Figure 31. VaR for Significant Portfolios of Covered Positions


	2016								2015
	Three months ended June 30,								Three months ended June 30,
in millions	High		Low		Mean		June 30,		High		Low		Mean		June 30,
Trading account assets:
Fixed income	$	1.2	$	.4	$	.6	$	.4	$	.9	$	.3	$	.6	$	.6
Derivatives:
Interest rate	$	.2		—	$	.1	$	.1	$	.1		.1	$	.1	$	.1
Credit		.2		—		.1		.2		.3	$	.1		.2		.1

Stressed VaR is calculated using our general VaR results at the 99% confidence level and applying certain assumptions. The aggregate stressed VaR for all covered positions was $2.7 million at June 30, 2016, and $2.9 million at June 30, 2015. Figure 32 summarizes our stressed VaR for significant portfolios of covered positions for the three months ended June 30, 2016, and June 30, 2015, as used for market risk capital charge calculation purposes.

Figure 32. Stressed VaR for Significant Portfolios of Covered Positions


	2016								2015
	Three months ended June 30,								Three months ended June 30,
in millions	High		Low		Mean		June 30,		High		Low		Mean		June 30,
Trading account assets:
Fixed income	$	2.9	$	1.1	$	1.8	$	1.2	$	2.6	$	.9	$	1.7	$	1.8
Derivatives:
Interest rate	$	.3	$	.1	$	.1	$	.2	$	.3	$	.2	$	.2	$	.2
Credit		.8		.1		.2		.8		.9		.2		.7		.4

Internal capital adequacy assessment. Market risk is a component of our internal capital adequacy assessment. Our risk-weighted assets include a market risk-equivalent asset position, which consists of a VaR component, stressed VaR component, a de minimis exposure amount, and a specific risk add-on, which are added together to arrive at total market risk equivalent assets. Specific risk is the price risk of individual financial instruments, which is not accounted for by changes in broad market risk factors and is measured through a standardized approach. Specific risk calculations are run quarterly by the MRM, and approved by the Chief Market Risk Officer.

Nontrading market risk

Most of our nontrading market risk is derived from interest rate fluctuations and its impacts on our traditional loan and deposit products, as well as investments, hedging relationships, long-term debt, and certain short-term borrowings. Interest rate risk, which is inherent in the banking industry, is measured by the potential for fluctuations in net interest income and the EVE. Such fluctuations may result from changes in interest rates and differences in the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities. We manage the exposure to changes in net interest income and the EVE in accordance with our risk appetite and within Board-approved policy limits.

Interest rate risk positions are influenced by a number of factors including the balance sheet positioning that arises out of consumer preferences for loan and deposit products, economic conditions, the competitive environment within our markets, changes in market interest rates that affect client activity, and our hedging, investing, funding, and capital positions. The primary components of interest rate risk exposure consist of reprice risk, basis risk, yield curve risk, and option risk.

The management of nontrading market risk is centralized within Corporate Treasury. The Risk Committee of our Board provides oversight of nontrading market risk. The ERM Committee and the ALCO review reports on the components of interest rate risk described above as well as sensitivity analyses of these exposures. These committees have various responsibilities related to managing nontrading market risk, including recommending, approving, and monitoring strategies that maintain risk positions within approved tolerance ranges. The A/LM policy provides the framework for the oversight and management of interest rate risk and is administered by the ALCO. Internal and external emerging issues are monitored on a daily basis. The MRM, as the second line of defense, provides additional oversight.

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•

“Reprice risk” is the exposure to changes in interest rates and occurs when the volume of interest-bearing liabilities and the volume of interest-earning assets they fund (e.g., deposits used to fund loans) do not mature or reprice at the same time.

•

“Basis risk” is the exposure to asymmetrical changes in interest rate indexes and occurs when floating-rate assets and floating-rate liabilities reprice at the same time, but in response to different market factors or indexes.

•

“Yield curve risk” is the exposure to non-parallel changes in the slope of the yield curve (where the yield curve depicts the relationship between the yield on a particular type of security and its term to maturity) and occurs when interest-bearing liabilities and the interest-earning assets that they fund do not price or reprice to the same term point on the yield curve.

•

“Option risk” is the exposure to a customer or counterparty’s ability to take advantage of the interest rate environment and terminate or reprice one of our assets, liabilities, or off-balance sheet instruments prior to contractual maturity without a penalty. Option risk occurs when exposures to customer and counterparty early withdrawals or prepayments are not mitigated with an offsetting position or appropriate compensation.

Net interest income simulation analysis. The primary tool we use to measure our interest rate risk is simulation analysis. For purposes of this analysis, we estimate our net interest income based on the current and projected composition of our on- and off-balance sheet positions, accounting for recent and anticipated trends in customer activity. The analysis also incorporates assumptions for the current and projected interest rate environments, including a most likely macro-economic scenario. Simulation modeling assumes that residual risk exposures will be managed to within the risk appetite and Board-approved policy limits.

We measure the amount of net interest income at risk by simulating the change in net interest income that would occur if the federal funds target rate were to gradually increase or decrease over the next 12 months, and term rates were to move in a similar direction, although at a slower pace. Our standard rate scenarios encompass a gradual increase or decrease of 200 basis points, but due to the low interest rate environment, we have modified the standard to a gradual decrease of 50 basis points over three months with no change over the following nine months. After calculating the amount of net interest income at risk to interest rate changes, we compare that amount with the base case of an unchanged interest rate environment. We also perform regular stress tests and sensitivities on the model inputs that could materially change the resulting risk assessments. One set of stress tests and sensitivities assesses the effect of interest rate inputs on simulated exposures. Assessments are performed using different shapes of the yield curve, including steepening or flattening of the yield curve, changes in credit spreads, an immediate parallel change in market interest rates, and changes in the relationship of money market interest rates. Another set of stress tests and sensitivities assesses the effect of loan and deposit assumptions and assumed discretionary strategies on simulated exposures. Assessments are performed on changes to the following assumptions: the pricing of deposits without contractual maturities; changes in lending spreads; prepayments on loans and securities; other loan and deposit balance shifts; investment, funding and hedging activities; and liquidity and capital management strategies.

Simulation analysis produces only a sophisticated estimate of interest rate exposure based on judgments related to assumption inputs into the simulation model. We tailor assumptions to the specific interest rate environment and yield curve shape being modeled, and validate those assumptions on a regular basis. Our simulations are performed with the assumption that interest rate risk positions will be actively managed through the use of on- and off-balance sheet financial instruments to achieve the desired residual risk profile. However, actual results may differ from those derived in simulation analysis due to unanticipated changes to the balance sheet composition, customer behavior, product pricing, market interest rates, investment, funding and hedging activities, and repercussions from unanticipated or unknown events.

Figure 33 presents the results of the simulation analysis at June 30, 2016, and June 30, 2015. At June 30, 2016, our simulated exposure to changes in interest rates was moderately asset sensitive, and net interest income would benefit over time from either an increase in short-term or intermediate-term interest rates. Tolerance levels for risk management require the development of remediation plans to maintain residual risk within tolerance if simulation modeling demonstrates that a gradual increase or decrease in short-term interest rates over the next 12 months would adversely affect net interest income over the same period by more than 4%. In December 2015, the Federal Reserve increased the range for the federal funds target rate, which led to an increased modeled exposure to declining interest rates. Subsequent to the Federal Reserve’s action in December, we increased the magnitude of the declining rate scenario to 50 basis points, increasing our overall modeled exposure. The modeled exposure depends on the relationships of interest rates on our interest earning assets and interest bearing liabilities, notably on instruments that are expected to react to the short end of the yield curve. As shown in Figure 33, we are operating within these levels as of June 30, 2016.

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Figure 33. Simulated Change in Net Interest Income


June 30, 2016
Basis point change assumption (short-term rates)	-50		+200
Tolerance level	-4.00	%	-4.00	%

Interest rate risk assessment	-3.37	%	2.22	%
June 30, 2015
Basis point change assumption (short-term rates)	-25		+200
Tolerance level	-4.00	%	-4.00	%

Interest rate risk assessment	-.99	%	2.79	%

The results of additional sensitivity analysis of alternate interest rate paths and loan and deposit behavior assumptions indicates that net interest income could increase or decrease from the base simulation results presented in Figure 33. Net interest income is highly dependent on the timing, magnitude, frequency, and path of interest rate increases and the associated assumptions for deposit repricing relationships, lending spreads, and the balance behavior of transaction accounts. The unprecedented low level of interest rates increases the uncertainty of assumptions for deposit balance behavior and deposit repricing relationships to market interest rates. Recent balance growth in deposits has caused the uncertainty in assumptions to increase further. Our historical deposit repricing betas in the last rising rate cycle ranged between 50% and 60% for interest-bearing deposits, and we continue to make similar assumptions in our modeling. The sensitivity testing of these assumptions supports our confidence that actual results are likely to be within a 100 basis point range of modeled results.

Key will continue to monitor balance sheet flows and expects the benefit from rising rates to increase modestly prior to any increase in the federal funds rate. Our current interest rate risk position could fluctuate to higher or lower levels of risk depending on the competitive environment and client behavior that may affect the actual volume, mix, maturity, and repricing characteristics of loan and deposit flows. As changes occur to both the configuration of the balance sheet and the outlook for the economy, management proactively evaluates hedging opportunities that may change our interest rate risk profile.

We also conduct simulations that measure the effect of changes in market interest rates in the second and third years of a three-year horizon. These simulations are conducted in a manner similar to those based on a 12-month horizon. To capture longer-term exposures, we calculate exposures to changes of the EVE as discussed in the following section.

Economic value of equity modeling. EVE complements net interest income simulation analysis as it estimates risk exposure beyond 12-, 24-, and 36-month horizons. EVE modeling measures the extent to which the economic values of assets, liabilities and off-balance sheet instruments may change in response to fluctuations in interest rates. EVE is calculated by subjecting the balance sheet to an immediate 200 basis point increase or decrease in interest rates, measuring the resulting change in the values of assets, liabilities and off-balance sheet instruments, and comparing those amounts with the base case of the current interest rate environment. Because the calculation of EVE under an immediate 200 basis point decrease in interest rates in the current low rate environment results in certain interest rates declining to zero and a less than 200 basis point decrease in certain yield curve term points, we have modified the standard declining rate scenario to an immediate 100 basis point decrease. This analysis is highly dependent upon assumptions applied to assets and liabilities with non-contractual maturities. Those assumptions are based on historical behaviors, as well as our expectations. We develop remediation plans that would maintain residual risk within tolerance if this analysis indicates that our EVE will decrease by more than 15% in response to an immediate increase or decrease in interest rates. We are operating within these guidelines as of June 30, 2016.

Management of interest rate exposure. We use the results of our various interest rate risk analyses to formulate A/LM strategies to achieve the desired risk profile while managing to our objectives for capital adequacy and liquidity risk exposures. Specifically, we manage interest rate risk positions by purchasing securities, issuing term debt with floating or fixed interest rates, and using derivatives — predominantly in the form of interest rate swaps, which modify the interest rate characteristics of certain assets and liabilities.

Figure 34 shows all swap positions that we hold for A/LM purposes. These positions are used to convert the contractual interest rate index of agreed-upon amounts of assets and liabilities (i.e., notional amounts) to another interest rate index. For example, fixed-rate debt is converted to a floating rate through a “receive fixed/pay variable” interest rate swap. The volume, maturity and mix of portfolio swaps change frequently as we adjust our broader A/LM objectives and the balance sheet positions to be hedged. For more information about how we use interest rate swaps to manage our risk profile, see Note 7 (“Derivatives and Hedging Activities”).

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Figure 34. Portfolio Swaps by Interest Rate Risk Management Strategy


	June 30, 2016
						Weighted-Average								June 30, 2015
dollars in millions	Notional Amount		Fair Value			Maturity (Years)		Receive Rate			Pay Rate			Notional Amount		Fair Value
Receive fixed/pay variable — conventional A/LM ^(a)	$	14,630	$	165			2.1		1.0	%		.5	%	$	10,455	$	1
Receive fixed/pay variable — conventional debt		8,005		353			3.6		1.7			.5			6,760		191
Pay fixed/receive variable — conventional debt		50		(12	)		12.0		.6			3.6			50		(5	)

Total portfolio swaps	$	22,685	$	506	^(b)		2.7		1.2	%		.5	%	$	17,265	$	187	^(b)

(a)	Portfolio swaps designated as A/LM are used to manage interest rate risk tied to both assets and liabilities.

(b)	Excludes accrued interest of $54 million and $58 million at June 30, 2016, and June 30, 2015, respectively.

Liquidity risk management

Liquidity risk, which is inherent in the banking industry, is measured by our ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund new business opportunities at a reasonable cost, in a timely manner, and without adverse consequences. Liquidity management involves maintaining sufficient and diverse sources of funding to accommodate planned, as well as unanticipated, changes in assets and liabilities under both normal and adverse conditions.

Governance structure

We manage liquidity for all of our affiliates on an integrated basis. This approach considers the unique funding sources available to each entity, as well as each entity’s capacity to manage through adverse conditions. The approach also recognizes that adverse market conditions or other events that could negatively affect the availability or cost of liquidity will affect the access of all affiliates to sufficient wholesale funding.

The management of consolidated liquidity risk is centralized within Corporate Treasury. Oversight and governance is provided by the Board, the ERM Committee, the ALCO, and the Chief Risk Officer. The Asset Liability Management Policy provides the framework for the oversight and management of liquidity risk and is administered by the ALCO. The MRM, as the second line of defense, provides additional oversight. Our current liquidity risk management practices are in compliance with the Federal Reserve Board’s Enhanced Prudential Standards and the OCC’s Heightened Standards for Large Insured National Banks.

These committees regularly review liquidity and funding summaries, liquidity trends, peer comparisons, variance analyses, liquidity projections, hypothetical funding erosion stress tests, and goal tracking reports. The reviews generate a discussion of positions, trends, and directives on liquidity risk and shape a number of our decisions. When liquidity pressure is elevated, positions are monitored more closely and reporting is more intensive. To ensure that emerging issues are identified, we also communicate with individuals inside and outside of the company on a daily basis.

Factors affecting liquidity

Our liquidity could be adversely affected by both direct and indirect events. An example of a direct event would be a downgrade in our public credit ratings by a rating agency. Examples of indirect events (events unrelated to us) that could impair our access to liquidity would be an act of terrorism or war, natural disasters, political events, or the default or bankruptcy of a major corporation, mutual fund or hedge fund. Similarly, market speculation, or rumors about us or the banking industry in general, may adversely affect the cost and availability of normal funding sources.

Following our announced acquisition of First Niagara in October 2015, S&P and Fitch affirmed Key’s ratings but changed the outlook to negative. Moody’s placed Key’s ratings under review for downgrade. On July 13, 2016, Moody’s subsequently confirmed Key’s ratings and changed the outlook from negative to stable, concluding their review.

Our credit ratings at June 30, 2016, are shown in Figure 35. We believe these credit ratings, under normal conditions in the capital markets, will enable KeyCorp or KeyBank to issue fixed income securities to investors.

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Figure 35. Credit Ratings

June 30, 2016

Short-Term
Borrowings

Long-Term
Deposits

Senior
Long-Term
Debt

Subordinated
Long-Term
Debt

Capital
Securities

Series A
Preferred
Stock

KEYCORP (THE PARENT COMPANY)

Standard & Poor’s

A-2

N/A

BBB+

BBB

BB+

Moody’s

P-2

N/A

Baa1

Baa2

Baa3

Fitch

N/A

A-

BBB+

BB+

DBRS

R-2(high)

N/A

BBB(high)

BBB

N/A

KEYBANK

Standard & Poor’s

A-2

N/A

A-

BBB+

N/A

Moody’s

P-1

Aa3

Baa1

N/A

Fitch

A-

BBB+

N/A

DBRS

R-1(low)

A(low)

BBB(high)

N/A

Managing liquidity risk

Most of our liquidity risk is derived from our lending activities, which inherently places funds into illiquid assets. Liquidity risk is also derived from our deposit gathering activities and the ability of our customers to withdraw funds that do not have a stated maturity or to withdraw funds before their contractual maturity. The assessments of liquidity risk are measured under the assumption of normal operating conditions as well as under a stressed environment. We manage these exposures in accordance with our risk appetite, and within Board-approved policy limits.

We regularly monitor our liquidity position and funding sources and measure our capacity to obtain funds in a variety of hypothetical scenarios in an effort to maintain an appropriate mix of available and affordable funding. In the normal course of business, we perform a monthly hypothetical funding erosion stress test for both KeyCorp and KeyBank. In a “heightened monitoring mode,” we may conduct the hypothetical funding erosion stress tests more frequently, and use assumptions to reflect the changed market environment. Our testing incorporates estimates for loan and deposit lives based on our historical studies. Hypothetical erosion stress tests analyze potential liquidity scenarios under various funding constraints and time periods. Ultimately, they determine the periodic effects that major direct and indirect events would have on our access to funding markets and our ability to fund our normal operations. To compensate for the effect of these assumed liquidity pressures, we consider alternative sources of liquidity and maturities over different time periods to project how funding needs would be managed.

We maintain a Contingency Funding Plan that outlines the process for addressing a liquidity crisis. The plan provides for an evaluation of funding sources under various market conditions. It also assigns specific roles and responsibilities for managing liquidity through a problem period. As part of the plan, we maintain on-balance sheet liquid reserves referred to as our liquid asset portfolio, which consists of high quality liquid assets. During a problem period, that reserve could be used as a source of funding to provide time to develop and execute a longer-term strategy. The liquid asset portfolio at June 30, 2016, totaled $20.0 billion, consisting of $13.7 billion of unpledged securities, $514 million of securities available for secured funding at the FHLB, and $5.8 billion of net balances of federal funds sold and balances in our Federal Reserve account. The liquid asset portfolio can fluctuate due to excess liquidity, heightened risk, or prefunding of expected outflows, such as debt maturities. Additionally, as of June 30, 2016, our unused borrowing capacity secured by loan collateral was $15.7 billion at the Federal Reserve Bank of Cleveland and $3 billion at the FHLB. During the second quarter of 2016, Key’s outstanding FHLB advances were reduced by $9.5 million due to repayments.

Final U.S. liquidity coverage ratio

Under the Liquidity Coverage Rules, we are required to calculate the Modified LCR for Key. Implementation for Modified LCR banking organizations, like Key, began on January 1, 2016, with a minimum requirement of 90% coverage, reaching 100% coverage by January 1, 2017. For the second quarter of 2016, our Modified LCR was above 100%. In the future, we may change the composition of our investment portfolio, increase the size of the overall investment portfolio, and/or modify product offerings to enhance or optimize our liquidity position.

Additional information about the Liquidity Coverage Ratio is included in the “Supervision and regulation” section under the heading “Liquidity coverage ratio” in Item 2 of this report.

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Long-term liquidity strategy

Our long-term liquidity strategy is to be predominantly funded by core deposits. However, we may use wholesale funds to sustain an adequate liquid asset portfolio, meet daily cash demands, and allow management flexibility to execute business initiatives. Key’s client-based relationship strategy provides for a strong core deposit base that, in conjunction with intermediate and long-term wholesale funds managed to a diversified maturity structure and investor base, supports our liquidity risk management strategy. We use the loan-to-deposit ratio as a metric to monitor these strategies. Our target loan-to-deposit ratio is 90-100% (at June 30, 2016, our loan-to-deposit ratio was 85%), which we calculate as total loans, loans held for sale, and nonsecuritized discontinued loans divided by total deposits.

Sources of liquidity

Our primary sources of liquidity include customer deposits, wholesale funding, and liquid assets. If the cash flows needed to support operating and investing activities are not satisfied by deposit balances, we rely on wholesale funding or on-balance sheet liquid reserves. Conversely, excess cash generated by operating, investing, and deposit-gathering activities may be used to repay outstanding debt or invest in liquid assets.

Liquidity programs

We have several liquidity programs, which are described in Note 18 (“Long-Term Debt”) beginning on page 208 of our 2015 Form 10-K, that are designed to enable KeyCorp and KeyBank to raise funds in the public and private debt markets. The proceeds from most of these programs can be used for general corporate purposes, including acquisitions. These liquidity programs are reviewed from time to time by the Board and are renewed and replaced as necessary. There are no restrictive financial covenants in any of these programs.

On May 20, 2016, KeyBank issued $600 million of 3.40% Subordinated Bank Notes due May 20, 2026, under its Global Bank Note Program.

Liquidity for KeyCorp

The primary source of liquidity for KeyCorp is from subsidiary dividends, primarily from KeyBank. KeyCorp has sufficient liquidity when it can service its debt; support customary corporate operations and activities (including acquisitions); support occasional guarantees of subsidiaries’ obligations in transactions with third parties at a reasonable cost, in a timely manner, and without adverse consequences; and pay dividends to shareholders.

We use a parent cash coverage months metric as the primary measure to assess parent company liquidity. The parent cash coverage months metric measures the months into the future where projected obligations can be met with the current amount of liquidity. We generally issue term debt to supplement dividends from KeyBank to manage our liquidity position at or above our targeted levels. The parent company generally maintains cash and short-term investments in an amount sufficient to meet projected debt maturities over at least the next 24 months. At June 30, 2016, KeyCorp held $2.9 billion in short-term investments, which we projected to be sufficient to meet our projected obligations, including the repayment of our maturing debt obligations for the periods prescribed by our risk tolerance.

Typically, KeyCorp meets its liquidity requirements through regular dividends from KeyBank, supplemented with term debt. Federal banking law limits the amount of capital distributions that a bank can make to its holding company without prior regulatory approval. A national bank’s dividend-paying capacity is affected by several factors, including net profits (as defined by statute) for the two previous calendar years and for the current year, up to the date of dividend declaration. During the second quarter of 2016, KeyBank paid $125 million in dividends to KeyCorp. As of June 30, 2016, KeyBank had regulatory capacity to pay $619 million in dividends to KeyCorp without prior regulatory approval.

Our liquidity position and recent activity

Over the past quarter, our liquid asset portfolio, which includes overnight and short-term investments, as well as unencumbered, high quality liquid securities held as protection against a range of potential liquidity stress scenarios, has increased as a result of an increase in unpledged securities and net customer loan and deposit flows. The liquid asset portfolio continues to exceed the amount that we estimate would be necessary to manage through an adverse liquidity event by providing sufficient time to develop and execute a longer-term solution.

From time to time, KeyCorp or KeyBank may seek to retire, repurchase, or exchange outstanding debt, capital securities, preferred shares, or common shares through cash purchase, privately negotiated transactions or other means. Additional

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information on repurchases of common shares by KeyCorp is included in Part II Item 2. Unregistered Sales of Equity Securities and Use of Proceeds of this report and in Part II, Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities on page 32 of our 2015 Form 10-K. Such transactions depend on prevailing market conditions, our liquidity and capital requirements, contractual restrictions, regulatory requirements, and other factors. The amounts involved may be material, individually or collectively.

We generate cash flows from operations and from investing and financing activities. We have approximately $204 million of cash and cash equivalents and short-term investments in international tax jurisdictions as of June 30, 2016. As we consider alternative long-term strategic and liquidity plans, opportunities to repatriate these amounts would result in approximately $3 million in taxes to be paid. We have included the appropriate amount as a deferred tax liability at June 30, 2016.

The Consolidated Statements of Cash Flows (Unaudited) summarize our sources and uses of cash by type of activity for the three-month periods ended June 30, 2016, and June 30, 2015.

Credit risk management

Credit risk is the risk of loss to us arising from an obligor’s inability or failure to meet contractual payment or performance terms. Like other financial services institutions, we make loans, extend credit, purchase securities, and enter into financial derivative contracts, all of which have related credit risk.

Credit policy, approval, and evaluation

We manage credit risk exposure through a multifaceted program. The Credit Risk Committee and the Commercial Credit Policy Committee approve retail and commercial credit policies. These policies are communicated throughout the organization to foster a consistent approach to granting credit.

Our credit risk management team and individuals within our lines of business to whom credit risk management has delegated authority are responsible for credit approval. Individuals with assigned credit authority are authorized to grant exceptions to credit policies. It is not unusual to make exceptions to established policies when mitigating circumstances dictate, however, a corporate level tolerance has been established to keep exceptions at an acceptable level based upon portfolio and economic considerations.

Most extensions of credit are subject to loan grading or scoring. Loan grades are assigned to commercial loans at the time of origination, verified by the credit risk management team and periodically reevaluated thereafter. This risk rating methodology blends our judgment with quantitative modeling. Commercial loans generally are assigned two internal risk ratings. The first rating reflects the probability that the borrower will default on an obligation; the second rating reflects expected loss rates on the credit facility. Default probability is determined based on, among other factors, the financial strength of the borrower, an assessment of the borrower’s management, the borrower’s competitive position within its industry sector, and our view of industry risk within the context of the general economic outlook. Types of exposure, transaction structure and collateral, including credit risk mitigants, affect the expected loss assessment.

Our credit risk management team uses risk models to evaluate consumer loans. These models, known as scorecards, forecast the probability of serious delinquency and default for an applicant. The scorecards are embedded in the application processing system, which allows for real-time scoring and automated decisions for many of our products. We periodically validate the loan grading and scoring processes.

We maintain an active concentration management program to mitigate concentration risk in our credit portfolios. For aggregate credit relationships, we employ a sliding scale of exposure, known as hold limits, which is dictated by the type of loan and strength of the borrower. Our legal lending limit is approximately $1.6 billion for any aggregate credit relationship. However, internal hold limits generally restrict the largest exposures to less than 20% of that amount. As of June 30, 2016, we had five client relationships with loan commitments net of credit default swaps of more than $200 million. The average amount outstanding on these five individual net obligor commitments was $58 million at June 30, 2016. In general, our philosophy is to maintain a diverse portfolio with regard to credit exposures.

We actively manage the overall loan portfolio in a manner consistent with asset quality objectives and concentration risk tolerances to mitigate portfolio credit risk. We utilize credit default swaps on a limited basis to transfer a portion of the credit risk associated with a particular extension of credit to a third party. At June 30, 2016, we used credit default swaps with a notional amount of $270 million to manage the credit risk associated with specific commercial lending obligations. We may also sell credit derivatives — primarily single name credit default swaps — to offset our purchased credit default swap position prior to maturity. At June 30, 2016, we did not have any sold credit default swaps outstanding.

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Credit default swaps are recorded on the balance sheet at fair value. Related gains or losses, as well as the premium paid or received for credit protection, are included in the “corporate services income” and “other income” components of noninterest income.

Allowance for loan and lease losses

At June 30, 2016, the ALLL was $854 million, or 1.38% of period-end loans, compared to $796 million, or 1.33%, at December 31, 2015, or $796 million, or 1.37%, at June 30, 2015. The allowance includes $41 million that was specifically allocated for impaired loans of $571 million at June 30, 2016, compared to $35 million that was specifically allocated for impaired loans of $308 million at December 31, 2015, and $52 million that was specifically allocated for impaired loans of $334 million at June 30, 2015. For more information about impaired loans, see Note 4 (“Asset Quality”). At June 30, 2016, the ALLL was 138% of nonperforming loans, compared to 205.7% at December 31, 2015, and 190% at June 30, 2015.

Selected asset quality statistics for each of the past five quarters are presented in Figure 36. The factors that drive these statistics are discussed in the remainder of this section.

Figure 36. Selected Asset Quality Statistics from Continuing Operations


	2016						2015
dollars in millions	Second			First			Fourth			Third			Second
Net loan charge-offs	$	43		$	46		$	37		$	41		$	36
Net loan charge-offs to average total loans		.28	%		.31	%		.25	%		.27	%		.25	%
Allowance for loan and lease losses	$	854		$	826		$	796		$	790		$	796
Allowance for credit losses ^(a)		904			895			852			844			841
Allowance for loan and lease losses to period-end loans		1.38	%		1.37	%		1.33	%		1.31	%		1.37	%
Allowance for credit losses to period-end loans		1.46			1.48			1.42			1.40			1.44
Allowance for loan and lease losses to nonperforming loans ^(b)		138.0			122.2			205.7			197.5			190.0
Allowance for credit losses to nonperforming loans ^(b)		146.0			132.4			220.2			211.0			200.7
Nonperforming loans at period end ^(b)	$	619		$	676		$	387		$	400		$	419
Nonperforming assets at period end ^(b)		637			692			403			417			440
Nonperforming loans to period-end portfolio loans ^(b)		1.00	%		1.12	%		.65	%		.67	%		.72	%
Nonperforming assets to period-end portfolio loans plus
OREO and other nonperforming assets ^(b)		1.03			1.14			.67			.69			.75

(a)	Includes the ALLL plus the liability for credit losses on lending-related unfunded commitments.

(b)	Nonperforming loan balances exclude $11 million, $11 million, $11 million, $12 million, and $12 million of PCI loans at June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, and June 30, 2015, respectively.

We estimate the appropriate level of the ALLL on at least a quarterly basis. The methodology used is described in Note 1 (“Summary of Significant Accounting Policies”) under the heading “Allowance for Loan and Lease Losses” beginning on page 122 of our 2015 Form 10-K. Briefly, our allowance applies expected loss rates to existing loans with similar risk characteristics. We exercise judgment to assess any adjustment to the expected loss rates for the impact of factors such as changes in economic conditions, lending policies including underwriting standards, and the level of credit risk associated with specific industries and markets.

For all commercial and consumer loan TDRs, regardless of size, as well as impaired commercial loans with an outstanding balance of $2.5 million or greater, we conduct further analysis to determine the probable loss content and assign a specific allowance to the loan if deemed appropriate. We estimate the extent of the individual impairment for commercial loans and TDRs by comparing the recorded investment of the loan with the estimated present value of its future cash flows, the fair value of its underlying collateral, or the loan’s observable market price. Secured consumer loan TDRs that are discharged through Chapter 7 bankruptcy and not formally re-affirmed are adjusted to reflect the fair value of the underlying collateral, less costs to sell. Other consumer loan TDRs are combined in homogenous pools and assigned a specific allocation based on the estimated present value of future cash flows using the effective interest rate. A specific allowance also may be assigned — even when sources of repayment appear sufficient — if we remain uncertain about whether the loan will be repaid in full. On at least a quarterly basis, we evaluate the appropriateness of our loss estimation methods to reduce differences between estimated incurred losses and actual losses. The ALLL at June 30, 2016, represents our best estimate of the probable credit losses inherent in the loan portfolio at that date.

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As shown in Figure 37, our ALLL from continuing operations increased by $58 million, or 7.3%, during the past 12 months. Our allowance applies expected loss rates to our existing loans with similar risk characteristics as well as any adjustments to reflect our current assessment of qualitative factors, such as changes in economic conditions, underwriting standards, and concentrations of credit. Our commercial ALLL increased by $64 million, or 9.9%, during the past 12 months, primarily because of loan growth and increased incurred loss estimates. The increase in these incurred loss estimates during 2015 and into 2016 was primarily due to the continued decline in oil and gas prices since 2014. Partially offsetting this increase was a decrease in our consumer ALLL of $6 million, or 4%, since June 30, 2015. Our consumer ALLL decrease was primarily due to continued improvement in credit metrics, such as delinquency, average credit bureau score, and loan to value, which have decreased expected loss rates since 2014. The continued improvement in the consumer portfolio credit quality metrics since 2014 was primarily due to continued improved credit quality and benefits of relatively stable economic conditions. Our liability for credit losses on lending-related commitments increased by $5 million to $50 million at June 30, 2016. When combined with our ALLL, our total allowance for credit losses represented 1.46% of period-end loans at June 30, 2016, compared to 1.42% at December 31, 2015, and 1.44% at June 30, 2015.

Figure 37. Allocation of the Allowance for Loan and Lease Losses


	June 30, 2016								December 31, 2015								June 30, 2015
dollars in millions	Amount		Percent of Allowance to Total Allowance			Percent of Loan Type to Total Loans			Amount		Percent of Allowance to Total Allowance			Percent of Loan Type to Total Loans			Amount		Percent of Allowance to Total Allowance			Percent of Loan Type to Total Loans
Commercial, financial and agricultural	$	513		60.1	%		53.8	%	$	450		56.5	%		52.2	%	$	418		52.5	%		50.3	%
Commercial real estate:
Commercial mortgage		135		15.8			13.8			134		16.8			13.3			144		18.1			13.5
Construction		17		2.0			1.4			25		3.2			1.7			31		3.9			2.2

Total commercial real estate loans		152		17.8			15.2			159		20.0			15.0			175		22.0			15.7
Commercial lease financing		45		5.2			6.4			47		5.9			6.7			53		6.7			6.8

Total commercial loans		710		83.1			75.4			656		82.4			73.9			646		81.2			72.8
Real estate — residential mortgage		18		2.1			3.7			18		2.3			3.7			20		2.5			3.9
Home equity loans		65		7.6			16.2			57		7.2			17.3			61		7.7			18.1
Consumer direct loans		19		2.3			2.6			20		2.5			2.7			21		2.6			2.7
Credit cards		30		3.5			1.3			32		4.0			1.3			31		3.9			1.3
Consumer indirect loans		12		1.4			.8			13		1.6			1.1			17		2.1			1.2

Total consumer loans		144		16.9			24.6			140		17.6			26.1			150		18.8			27.2

Total loans ^(a)	$	854		100.0	%		100.0	%	$	796		100.0	%		100.0	%	$	796		100.0	%		100.0	%

(a)	Excludes allocations of the ALLL related to the discontinued operations of the education lending business in the amount of $20 million, $28 million, and $22 million at June 30, 2016, December 31, 2015, and June 30, 2015, respectively.

Our provision for credit losses was $52 million for the second quarter of 2016, compared to $41 million for the second quarter of 2015. The increase in our provision is primarily due to the growth in our loan portfolio over the past twelve months and increased charge-offs, primarily in the oil and gas portfolio, compared to the first six months of 2015. We continue to reduce our exposure in our higher-risk businesses, including the residential properties portion of our construction loan portfolio, marine/RV financing, and other selected leasing portfolios through the sale of certain loans, payments from borrowers, or net loan charge-offs.

Asset quality on our oil and gas loan portfolio, which represents approximately 2% of total loans at June 30, 2016, is performing in-line with expectations. Our reserve for credit losses allocated to our oil and gas loan exposure was 8% of the total oil and gas loan portfolio at June 30, 2016, up from 6% at December 31, 2015, and reflected the estimated impact of current oil prices at that date.

Net loan charge-offs

Net loan charge-offs for the second quarter of 2016 totaled $43 million, or .28% of average loans, compared to net loan charge-offs of $36 million, or .25%, for the same period last year. Figure 38 shows the trend in our net loan charge-offs by loan type, while the composition of loan charge-offs and recoveries by type of loan is presented in Figure 39.

Over the past 12 months, net loan charge-offs increased $7 million. This increase is primarily attributable to growth and higher charge-offs in our commercial loan portfolio, partially offset by a decline in the consumer loan portfolio over the same period. As shown in Figure 41, our exit loan portfolio contributed a total of $5 million in net loan charge-offs for the second quarter of 2016, compared to $4 million in net loan charge-offs for the second quarter of 2015. The increase in net loan charge-offs in our exit loan portfolio was primarily driven by higher levels of net loan charge-offs in our commercial exit loan portfolio.

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Figure 38. Net Loan Charge-offs from Continuing Operations^(a)


	2016						2015
dollars in millions	Second			First			Fourth			Third			Second
Commercial, financial and agricultural	$	32		$	23		$	15		$	24		$	15
Real estate — Commercial mortgage		(4	)		(1	)		(2	)		—			—
Real estate — Construction		—			(1	)		—			—			(1	)
Commercial lease financing		1			3			6			—			—

Total commercial loans		29			24			19			24			14
Real estate — Residential mortgage		1			—			—			1			—
Home equity loans		3			7			5			3			8
Consumer direct loans		4			5			5			5			4
Credit cards		7			7			7			6			7
Consumer indirect loans		(1	)		3			1			2			3

Total consumer loans		14			22			18			17			22

Total net loan charge-offs	$	43		$	46		$	37		$	41		$	36

Net loan charge-offs to average loans		.28	%		.31	%		.25	%		.27	%		.25	%
Net loan charge-offs from discontinued operations — education lending business	$	4		$	6		$	7		$	7		$	2

(a)	Credit amounts indicate that recoveries exceeded charge-offs.

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Figure 39. Summary of Loan and Lease Loss Experience from Continuing Operations


	Three months ended June 30,						Six months ended June 30,
dollars in millions	2016			2015			2016			2015
Average loans outstanding	$	61,148		$	57,978		$	60,652		$	57,746

Allowance for loan and lease losses at beginning of period	$	826		$	794		$	796		$	794
Loans charged off:
Commercial, financial and agricultural		35			21			61			33
Real estate — commercial mortgage		2			—			3			2
Real estate — construction		—			—			—			1

Total commercial real estate loans^(a)		2			—			3			3
Commercial lease financing		3			1			6			3

Total commercial loans^(b)		40			22			70			39
Real estate — residential mortgage		1			1			3			3
Home equity loans		7			10			17			18
Consumer direct loans		6			6			12			12
Credit cards		8			8			16			16
Consumer indirect loans		2			5			6			11

Total consumer loans		24			30			54			60

Total loans charged off		64			52			124			99
Recoveries:
Commercial, financial and agricultural		3			6			6			11
Real estate — commercial mortgage		6			—			8			2
Real estate — construction		—			1			1			1

Total commercial real estate loans^(a)		6			1			9			3
Commercial lease financing		2			1			2			5

Total commercial loans^(b)		11			8			17			19
Real estate — residential mortgage		—			1			2			1
Home equity loans		4			2			7			5
Consumer direct loans		2			2			3			4
Credit cards		1			1			2			1
Consumer indirect loans		3			2			4			5

Total consumer loans		10			8			18			16

Total recoveries		21			16			35			35

Net loan charge-offs		(43	)		(36	)		(89	)		(64	)
Provision (credit) for loan and lease losses		71			37			147			66
Foreign currency translation adjustment		—			1			—			—

Allowance for loan and lease losses at end of period	$	854		$	796		$	854		$	796

Liability for credit losses on lending-related commitments at beginning of period	$	69		$	41		$	56		$	35
Provision (credit) for losses on lending-related commitments		(19	)		4			(6	)		10

Liability for credit losses on lending-related commitments at end of period^(c)	$	50		$	45		$	50		$	45

Total allowance for credit losses at end of period	$	904		$	841		$	904		$	841

Net loan charge-offs to average total loans		.28	%		.25	%		.30	%		.22	%
Allowance for loan and lease losses to period-end loans		1.38			1.37			1.38			1.37
Allowance for credit losses to period-end loans		1.46			1.44			1.46			1.44
Allowance for loan and lease losses to nonperforming loans		138.0			190.0			138.0			190.0
Allowance for credit losses to nonperforming loans		146.0			200.7			146.0			200.7
Discontinued operations — education lending business:
Loans charged off	$	6		$	6		$	15		$	16
Recoveries		2			4			5			8

Net loan charge-offs	$	(4	)	$	(2	)	$	(10	)	$	(8	)

(a)	See Figure 20 and the accompanying discussion in the “Loans and loans held for sale” section for more information related to our commercial real estate loan portfolio.

(b)	See Figure 19 and the accompanying discussion in the “Loans and loans held for sale” section for more information related to our commercial loan portfolio.

(c)	Included in “accrued expense and other liabilities” on the balance sheet.

139

Nonperforming assets

Figure 40 shows the composition of our nonperforming assets. These assets totaled $637 million at June 30, 2016, and represented 1.03% of period-end portfolio loans, OREO and other nonperforming assets, compared to $403 million, or .67%, at December 31, 2015, and $440 million, or .75%, at June 30, 2015. See Note 1 (“Summary of Significant Accounting Policies”) under the headings “Nonperforming Loans,” “Impaired Loans,” and “Allowance for Loan and Lease Losses” beginning on page 121 of our 2015 Form 10-K for a summary of our nonaccrual and charge-off policies.

Figure 40. Summary of Nonperforming Assets and Past Due Loans from Continuing Operations


dollars in millions	June 30, 2016			March 31, 2016			December 31, 2015			September 30, 2015			June 30, 2015
Commercial, financial and agricultural	$	321		$	380		$	82		$	89		$	100
Real estate — commercial mortgage		14			16			19			23			26
Real estate — construction		25			12			9			9			12

Total commercial real estate loans ^(a)		39			28			28			32			38
Commercial lease financing		10			11			13			21			18

Total commercial loans^(b)		370			419			123			142			156
Real estate — residential mortgage		54			59			64			67			67
Home equity loans		189			191			190			181			184
Consumer direct loans		1			1			2			1			1
Credit cards		2			2			2			2			2
Consumer indirect loans		3			4			6			7			9

Total consumer loans		249			257			264			258			263

Total nonperforming loans^(c)		619			676			387			400			419
OREO		15			14			14			17			20
Other nonperforming assets		3			2			2			—			1

Total nonperforming assets^(c)	$	637		$	692		$	403		$	417		$	440

Accruing loans past due 90 days or more	$	70		$	70		$	72		$	54		$	66
Accruing loans past due 30 through 89 days		203			237			208			271			181
Restructured loans — accruing and nonaccruing^(d)		277			283			280			287			300
Restructured loans included in nonperforming loans^(d)		133			151			159			160			170
Nonperforming assets from discontinued operations — education lending business		5			6			7			8			6
Nonperforming loans to period-end portfolio loans^(c)		1.00	%		1.12	%		.65	%		.67	%		.72	%
Nonperforming assets to period-end portfolio loans plus OREO and other nonperforming assets^(c)		1.03			1.14			.67			.69			.75

(a)	See Figure 20 and the accompanying discussion in the “Loans and loans held for sale” section for more information related to our commercial real estate loan portfolio.

(b)	See Figure 19 and the accompanying discussion in the “Loans and loans held for sale” section for more information related to our commercial loan portfolio.

(c)	Nonperforming loan balances exclude $11 million, $11 million, $11 million, $12 million, and $12 million of PCI loans at June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, and June 30, 2015, respectively.

(d)

Restructured loans (i.e., TDRs) are those for which Key, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. These concessions are made to improve the collectability of the loan and generally take the form of a reduction of the interest rate, extension of the maturity date or reduction in the principal balance.

As shown in Figure 40, nonperforming assets at June 30, 2016, increased $197 million from one year ago. Increases in nonperforming assets in the commercial, financial and agricultural portfolio, which were primarily due to the credit migration in the oil and gas portfolio, were partially offset by declines in nonperforming assets in the commercial lease financing and consumer loan portfolios. As shown in Figure 41, our exit loan portfolio accounted for $14 million, or 2%, of our total nonperforming assets at June 30, 2016, compared to $26 million, or 6%, at June 30, 2015.

At June 30, 2016, the approximate carrying amount of our commercial nonperforming loans outstanding represented 83% of their contractual amount owed, total nonperforming loans outstanding represented 83% of their contractual amount owed, and nonperforming assets in total were carried at 83% of their original contractual amount owed. At the same date, OREO and other nonperforming assets represented 75% of its original contractual amount owed.

At June 30, 2016, our 20 largest nonperforming loans totaled $331 million, representing 54% of total nonperforming loans. At June 30, 2015, our 20 largest nonperforming loans totaled $120 million, representing 29% of total nonperforming loans.

Figure 41 shows the composition of our exit loan portfolio at June 30, 2016, and June 30, 2015, the net loan charge-offs recorded on this portfolio for the second quarter of 2016 and the second quarter of 2015, and the nonperforming status of these loans at June 30, 2016, and June 30, 2015. The exit loan portfolio represented 2% of total loans and loans held for sale at June 30, 2016, and 3% of total loans and loans held for sale at June 30, 2015.

140

Figure 41. Exit Loan Portfolio from Continuing Operations


	Balance Outstanding				Change 6-30-16 vs. 6-30-15			Net Loan Charge-offs				Balance on Nonperforming Status
in millions	6-30-16		6-30-15		Change 6-30-16 vs. 6-30-15			6-30-16		6-30-15		6-30-16		6-30-15
Residential properties — homebuilder		—	$	6	$	(6	)		—		—	$	4	$	8
Marine and RV floor plan		—		2		(2	)		—		—		—		1
Commercial lease financing^(a)	$	731		831		(100	)	$	1		—		—		—

Total commercial loans		731		839		(108	)		1		—		4		9
Home equity — Other		183		236		(53	)		1	$	1		7		8
Marine		496		673		(177	)		3		3		3		8
RV and other consumer		35		47		(12	)		—		—		—		1

Total consumer loans		714		956		(242	)		4		4		10		17

Total exit loans in loan portfolio	$	1,445	$	1,795	$	(350	)	$	5	$	4	$	14	$	26

Discontinued operations — education lending business (not included in exit loans above)	$	1,692	$	1,962	$	(270	)	$	4	$	2	$	5	$	6

(a)

Includes (1) the business aviation, commercial vehicle, office products, construction, and industrial leases; (2) Canadian lease financing portfolios; (3) European lease financing portfolios; and (4) all remaining balances related to lease in, lease out; sale in, lease out; service contract leases; and qualified technological equipment leases.

Figure 42 shows the types of activity that caused the change in our nonperforming loans during each of the last five quarters.

Figure 42. Summary of Changes in Nonperforming Loans from Continuing Operations


	2016						2015
in millions	Second			First			Fourth			Third			Second
Balance at beginning of period	$	676		$	387		$	400		$	419		$	437
Loans placed on nonaccrual status		124			406			81			81			92
Charge-offs		(64	)		(60	)		(51	)		(53	)		(52	)
Loans sold		—			(11	)		—			(2	)		—
Payments		(75	)		(8	)		(21	)		(16	)		(25	)
Transfers to OREO		(6	)		(4	)		(4	)		(4	)		(5	)
Transfers to other nonperforming assets		—			—			(1	)		—			—
Loans returned to accrual status		(36	)		(34	)		(17	)		(25	)		(28	)

Balance at end of period^(a)	$	619		$	676		$	387		$	400		$	419

(a)	Nonperforming loan balances exclude $11 million, $11 million, $11 million, $12 million, and $12 million of PCI loans at June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, and June 30, 2015, respectively.

Figure 43 shows the factors that contributed to the change in our OREO during each of the last five quarters.

Figure 43. Summary of Changes in Other Real Estate Owned, Net of Allowance, from Continuing Operations


	2016						2015
in millions	Second			First			Fourth			Third			Second
Balance at beginning of period	$	14		$	14		$	17		$	20		$	20
Properties acquired — nonperforming loans		6			4			4			4			5
Valuation adjustments		(2	)		(1	)		(2	)		(2	)		(1	)
Properties sold		(3	)		(3	)		(5	)		(5	)		(4	)

Balance at end of period	$	15		$	14		$	14		$	17		$	20

141

Operational and compliance risk management

Like all businesses, we are subject to operational risk, which is the risk of loss resulting from human error or malfeasance, inadequate or failed internal processes and systems, and external events. These events include, among other things, threats to our cybersecurity, as we are reliant upon information systems and the Internet to conduct our business activities.

Operational risk also encompasses compliance risk, which is the risk of loss from violations of, or noncompliance with, laws, rules and regulations, prescribed practices, and ethical standards. Under the Dodd-Frank Act, large financial companies like Key are subject to heightened prudential standards and regulation. This heightened level of regulation has increased our operational risk. We have created work teams to respond to and analyze the regulatory requirements that have been or will be promulgated as a result of the enactment of the Dodd-Frank Act. Resulting operational risk losses and/or additional regulatory compliance costs could take the form of explicit charges, increased operational costs, harm to our reputation, or foregone opportunities.

We seek to mitigate operational risk through identification and measurement of risk, alignment of business strategies with risk appetite and tolerance, and a system of internal controls and reporting. We continuously strive to strengthen our system of internal controls to improve the oversight of our operational risk and to ensure compliance with laws, rules, and regulations. For example, an operational event database tracks the amounts and sources of operational risk and losses. This tracking mechanism helps to identify weaknesses and to highlight the need to take corrective action. We also rely upon software programs designed to assist in assessing operational risk and monitoring our control processes. This technology has enhanced the reporting of the effectiveness of our controls to senior management and the Board.

The Operational Risk Management Program provides the framework for the structure, governance, roles, and responsibilities, as well as the content, to manage operational risk for Key. The Compliance Risk Committee serves the same function in managing compliance risk for Key. Primary responsibility for managing and monitoring internal control mechanisms lies with the managers of our various lines of business. The Operational Risk Committee and Compliance Risk Committee are senior management committees that oversee our level of operational and compliance risk and direct and support our operational and compliance infrastructure and related activities. These committees and the Operational Risk Management and Compliance functions are an integral part of our ERM Program. Our Risk Review function regularly assesses the overall effectiveness of our Operational Risk Management and Compliance Programs and our system of internal controls. Risk Review reports the results of reviews on internal controls and systems to senior management and the Risk and Audit Committees and independently supports the Risk Committee’s oversight of these controls.

Cybersecurity

We maintain comprehensive Cyber Incident Response Plans, and we devote significant time and resources to maintaining and regularly updating our technology systems and processes to protect the security of our computer systems, software, networks, and other technology assets against attempts by third parties to obtain unauthorized access to confidential information, destroy data, disrupt or degrade service, sabotage systems, or cause other damage. We and many other U.S. financial institutions have experienced distributed denial-of-service attacks from technologically sophisticated third parties. These attacks are intended to disrupt or disable consumer online banking services and prevent banking transactions. We also periodically experience other attempts to breach the security of our systems and data. These cyberattacks have not, to date, resulted in any material disruption of our operations or material harm to our customers, and have not had a material adverse effect on our results of operations.

Cyberattack risks may also occur with our third-party technology service providers, and may interfere with their ability to fulfill their contractual obligations to us, with attendant potential for financial loss or liability that could adversely affect our financial condition or results of operations. Recent high-profile cyberattacks have targeted retailers and other businesses for the purpose of acquiring the confidential information (including personal, financial, and credit card information) of customers, some of whom are customers of ours. We may incur expenses related to the investigation of such attacks or related to the protection of our customers from identity theft as a result of such attacks. Risks and exposures related to cyberattacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking, and other technology-based products and services by us and our clients.

142

Critical Accounting Policies and Estimates

Our business is dynamic and complex. Consequently, we must exercise judgment in choosing and applying accounting policies and methodologies. These choices are critical – not only are they necessary to comply with GAAP, they also reflect our view of the appropriate way to record and report our overall financial performance. All accounting policies are important, and all policies described in Note 1 (“Summary of Significant Accounting Policies”) beginning on page 119 of our 2015 Form 10-K should be reviewed for a greater understanding of how we record and report our financial performance.

In our opinion, some accounting policies are more likely than others to have a critical effect on our financial results and to expose those results to potentially greater volatility. These policies apply to areas of relatively greater business importance, or require us 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 prove to be inaccurate, or we may find it necessary to change them.

We rely heavily on the use of judgment, assumptions, and estimates to make a number of core decisions, including accounting for the ALLL; contingent liabilities, guarantees and income taxes; derivatives and related hedging activities; and assets and liabilities that involve valuation methodologies. In addition, we may employ outside valuation experts to assist us in determining fair values of certain assets and liabilities. A brief discussion of each of these areas appears on pages 103 through 107 of our 2015 Form 10-K.

At June 30, 2016, $17 billion, or 17%, of our total assets were measured at fair value on a recurring basis. Approximately 99% of these assets, before netting adjustments, were classified as Level 1 or Level 2 within the fair value hierarchy. At June 30, 2016, $1 billion, or 2%, of our total liabilities were measured at fair value on a recurring basis. All of these liabilities were classified as Level 1 or Level 2.

During the second quarter of 2016, $12 million of our total assets were measured at fair value on a nonrecurring basis. All of these assets were classified as Level 3. At June 30, 2016, there were no liabilities measured at fair value on a nonrecurring basis.

During the first six months of 2016, we did not significantly alter the manner in which we applied our critical accounting policies or developed related assumptions and estimates.

143

European Sovereign and Non-Sovereign Debt Exposures

Our total European sovereign and non-sovereign debt exposure is presented in Figure 44.

Figure 44. European Sovereign and Non-Sovereign Debt Exposures


June 30, 2016 in millions	Short-and Long- Term Commercial Total ^(a)		Foreign Exchange and Derivatives with Collateral ^(b)			Net Exposure
France:
Sovereigns		—		—			—
Non-sovereign financial institutions		—	$	3		$	3
Non-sovereign non-financial institutions	$	13		—			13

Total		13		3			16
Germany:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		186		—			186

Total		186		—			186
Greece:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		—		—			—

Total		—		—			—
Iceland:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		—		—			—

Total		—		—			—
Ireland:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		—		—			—

Total		—		—			—
Italy:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		27		—			27

Total		27		—			27
Netherlands:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		10		—			10

Total		10		—			10
Portugal:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		—		—			—

Total		—		—			—
Spain:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		16		—			16

Total		16		—			16
Switzerland:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		(2	)		(2	)
Non-sovereign non-financial institutions		60		—			60

Total		60		(2	)		58
United Kingdom:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		149			149
Non-sovereign non-financial institutions		71		—			71

Total		71		149			220
Other Europe:^(c)
Sovereigns		—		—			—
Non-sovereign financial institutions		—		—			—
Non-sovereign non-financial institutions		67		—			67

Total		67		—			67
Total Europe:
Sovereigns		—		—			—
Non-sovereign financial institutions		—		150			150
Non-sovereign non-financial institutions		450		—			450

Total	$	450	$	150		$	600

(a)	Represents our outstanding leases.

(b)

Represents contracts to hedge our balance sheet asset and liability needs, and to accommodate our clients’ trading and/or hedging needs. Our derivative mark-to-market exposures are calculated and reported on a daily basis. These exposures are largely covered by cash or highly marketable securities collateral with daily collateral calls.

(c)

Other Europe consists of the following countries: Austria, Belarus, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Finland, Hungary, Lithuania, Luxembourg, Malta, Norway, Poland, Romania, Russia, Slovakia, Slovenia, Sweden, and Ukraine. 100% of our exposure in Other Europe is in Belgium, Finland, and Sweden.

Our credit risk exposure is largely concentrated in developed countries with emerging market exposure essentially limited to commercial facilities; these exposures are actively monitored by management. We do not have at-risk exposures in the rest of the world.

144

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

The information presented in the “Market risk management” section of the Management’s Discussion & Analysis of Financial Condition & Results of Operations is incorporated herein by reference.

Item 4.

Controls and Procedures

As of the end of the period covered by this report, KeyCorp carried out an evaluation, under the supervision and with the participation of KeyCorp’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of KeyCorp’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)), to ensure that information required to be disclosed by KeyCorp in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to KeyCorp’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon that evaluation, KeyCorp’s Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective, in all material respects, as of the end of the period covered by this report. No changes were made to KeyCorp’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, KeyCorp’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

The information presented in the Legal Proceedings section of Note 15 (“Contingent Liabilities and Guarantees”) of the Notes to Consolidated Financial Statements (Unaudited) is incorporated herein by reference.

On at least a quarterly basis, we assess our liabilities and contingencies in connection with outstanding legal proceedings utilizing the latest information available. Where it is probable that we will incur a loss and the amount of the loss can be reasonably estimated, we record a liability in our consolidated financial statements. These legal reserves may be increased or decreased to reflect any relevant developments on a quarterly basis. Where a loss is not probable or the amount of the loss is not estimable, we have not accrued legal reserves, consistent with applicable accounting guidance. Based on information currently available to us, advice of counsel, and available insurance coverage, we believe that our established reserves are adequate and the liabilities arising from the legal proceedings will not have a material adverse effect on our consolidated financial condition. We note, however, that in light of the inherent uncertainty in legal proceedings there can be no assurance that the ultimate resolution will not exceed established reserves. As a result, the outcome of a particular matter or a combination of matters may be material to our results of operations for a particular period, depending upon the size of the loss or our income for that particular period.

Item 1A.

Risk Factors

For a discussion of certain risk factors affecting us, see the section titled “Supervision and Regulation” in Part I, Item 1. Business, on pages 9-18 of our 2015 Form 10-K; Part I, Item 1A. Risk Factors, on pages 18-30 of our 2015 Form 10-K; the section titled “Supervision and regulation” in this Form 10-Q; and our disclosure regarding forward-looking statements in this Form 10-Q.

145

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

From time to time, KeyCorp or its principal subsidiary, KeyBank, may seek to retire, repurchase, or exchange outstanding debt of KeyCorp or KeyBank, and capital securities or preferred stock of KeyCorp, through cash purchase, privately negotiated transactions, or otherwise. Such transactions, if any, depend on prevailing market conditions, our liquidity and capital requirements, contractual restrictions, and other factors. The amounts involved may be material.

Common share repurchases under the 2015 capital plan began in the second quarter of 2015 and were suspended in the fourth quarter of 2015 in connection with the announcement of our acquisition of First Niagara. In April 2016, we submitted to the Federal Reserve and provided to the OCC our 2016 capital plan under the annual CCAR process. On June 29, 2016, the Federal Reserve announced that it did not object to our 2016 capital plan. Share repurchases of up to $350 million were included in the 2016 capital plan, which is effective through the second quarter of 2017. We anticipate repurchasing common shares in the third quarter of 2016 following the completion of the acquisition of First Niagara.

The following table summarizes our repurchases of our common shares for the three months ended June 30, 2016.


Calendar month	Total number of shares repurchased ^(a)		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs		Maximum number of shares that may yet be purchased as part of publicly announced plans or programs ^(b)
April 1 — 30		1,406	$	11.08		—		37,658,833
May 1 — 31		2,087		11.54		—		36,100,077
June 1 — 30		1,066		12.85		—		41,881,384

Total		4,559	$	11.70		—

(a)	Includes common shares deemed surrendered by employees in connection with our stock compensation and benefit plans to satisfy tax obligations. There were no common shares repurchased in the open market during the second quarter of 2016.

(b)	Calculated using the remaining general repurchase amount divided by the closing price of KeyCorp common shares as follows: on April 30, 2016, at $12.29; on May 31, 2016, at $12.82; and on June 30, 2016, at $11.05.

Item 6.

Exhibits



3		Second Amended and Restated Articles of Incorporation of KeyCorp, effective August 1, 2016, filed as Exhibit 3.1 to Form 8-K on August 1, 2016.*

15		Acknowledgment of Independent Registered Public Accounting Firm.

31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101		The following materials from KeyCorp’s Form 10-Q Report for the quarterly period ended June 30, 2016, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income, (iii) the Consolidated Statements of Changes in Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to Consolidated Financial Statements.

Incorporated by reference. Copies of these Exhibits have been filed with the SEC. Exhibits that are not incorporated by reference are filed with this report. Shareholders may obtain a copy of any exhibit, upon payment of reproductions costs, by writing KeyCorp Investor Relations, 127 Public Square, Mail Code OH-01-27-0737, Cleveland, OH 44114-1306.

Information Available on Website

KeyCorp makes available free of charge on its website, www.key.com, its 2015 Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports as soon as reasonably practicable after KeyCorp electronically files such material with, or furnishes it to, the SEC. We also make available a summary of filings made with the SEC of statements of beneficial ownership of our equity securities filed by our directors and officers under Section 16 of the Exchange Act. The “Regulatory Disclosures and Filings” tab of the investor relations section of our website includes public disclosures concerning our annual and mid-year stress-testing activities under the Dodd-Frank Act. Information contained on or accessible through our website or any other website referenced in this report is not part of this report.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the date indicated.


		KEYCORP
		(Registrant)

Date: August 5, 2016		/s/ Douglas M. Schosser
		By: Douglas M. Schosser
		Chief Accounting Officer (Principal Accounting Officer)

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