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KeyCorp’s Top Down & Bottom Up Capital Reconcilement.

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Presentation on theme: "KeyCorp’s Top Down & Bottom Up Capital Reconcilement."— Presentation transcript:

1 KeyCorp’s Top Down & Bottom Up Capital Reconcilement

2 Eric Falkenstein 4/14/992 Integration Bottom up economic capital estimations must be melded with top down economic requirements Regulatory needs must be reconciled with true risk

3 Eric Falkenstein 4/14/993 KeyCorp’s Solution Key’s main capital ratio target is for a 6.25% tangible equity/tangible asset ratio This is influenced by peer comparisons and regulatory requirements To make this consistent with the bottom up approach, we adjust the economic capital estimates proportionally to match our top-down target

4 Eric Falkenstein 4/14/994 Peer Comparisons


6 Eric Falkenstein 4/14/996

7 7 Key’s Top Down View

8 Eric Falkenstein 4/14/998 The optimal capitalization range is dependent on the business mix and management targets for debt rating and beta. Given KeyCorp’s current business mix, a target debt rating of single-A, and a beta of around 1.1, KeyCorp estimates that its optimal capitalization range is a tangible equity/tangible asset ratio between 6.0% and 6.5%. The charts below show how the impact of leverage on ROE and required return results in an optimal capitalization range for maximizing shareholder value. HOW LEVERAGE IMPACTS ROE, REQUIRED RETURN, AND STOCK PRICE Optimal Capitalization Range Higher leverage initially leads to higher ROE, but eventually high debt costs put a cap on this......while the post-tax math of leverage versus required return follows a different pattern......resulting in an “optimal” leverage area for maximizing shareholder value: High ROE Low High LEVERAGE Decreasing Credit Rating Increasing Beta Low High + K e High MBMB KeyCorp Tangible Equity Ratio Target: 6-6.5% Optimal Leverage Range Beta: 1.1 Target Debt Rating: A Low High

9 Eric Falkenstein 4/14/999 Summary of Management Targets/Estimates The following is a summary of the targets and estimates that KeyCorp management has initially adopted for the purpose of calculating economic capital allocations. They should be reviewed at least annually and reaffirmed or amended, as required.

10 Eric Falkenstein 4/14/9910 Implied risk coverage level* * - A risk coverage level of 99.5% implies that economic capital will cover 99.5% of potential loss outcomes ** - FMCG recommends using the 5-year implied risk coverage level because five years is a mid-range maturity for the senior debt that banks most frequently issue Capital Allocations Are A Function of the Risk Coverage Level, Which Is Driven By Keycorp’s Target Debt Rating...

11 Eric Falkenstein 4/14/9911 Top-Down Target Top-Down Total 6.25% Tangible Equity 5.00% Special Loss Reserve Risk-Based Regulatory Minimums Acquisition Reserve.50%.75%

12 Eric Falkenstein 4/14/9912 Reconcilement

13 Eric Falkenstein 4/14/9913 $1.2B $200 $500 $1.3B $200 $220 $550 $110 $100 Bottom-Up Allocation (First-Cut) Optimal Capitalization Level (Final Capital Allocation) Fixed Assets and Goodwill Other Intangible Asset Risk Operational/Operating Leverage Risk Interest Rate/ Market Risk Credit Risk Capital ($mm) Fixed Assets and Goodwill* Other Intangible Asset Risk Operational/Operating Leverage Risk Interest Rate/ Market Risk Credit Risk * -- Fixed assets and goodwill capital allocations are not adjusted as they are assigned using what is in essence a top-down methodology. ------------------------ Reconcile Bottom-up Capital Allocations To The Top-down Optimal Capitalization Range

14 Eric Falkenstein 4/14/9914 Technical Point Since only up to 100% of an asset can be funded by equity, items receiving 100% equity allocations are not affected by the proportional adjustment (e.g., goodwill)

15 Eric Falkenstein 4/14/9915 Example Assume Key has $100 in assets, and thus a $6.25 top down capital target Original Adjusted commercial $ 2.00 $ 3.50 consumer $ 1.00 $ 1.75 goodwill $ 1.00 $ 1.00 Sum $ 4.00 $ 6.25 Note after adjustment, the bottom up equals the top down target

16 Eric Falkenstein 4/14/9916 Strategy Motivation The essence of the top down numbers is their relative proportions, not their absolute levels As long as the bottom up numbers are close to the top down numbers, distortions are secondary If bottom up and top down diverge too much, this should motivate strategic behavior at the corporate level to bring things back into balance

17 Eric Falkenstein 4/14/9917 The Future The Federal Reserve’s Board of Governors has put out a discussion paper concerning the move towards internal models for capital for credit, just as they use now for market risk Our capital allocations anticipate this movement so that we can hit the ground running when any change occurs

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