NOTES TO CONSOLIDATED FINANCIAL STATEMENTS KEYCORP AND SUBSIDIARIES Key also uses “pay fixed/receive variable” interest rate swaps to manage the interest rate risk associated with anticipated sales or securitizations of certain commercial real estate loans. These swaps protect against a 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 securitized or sold. Key’s general policy is to sell or securitize these loans within one year of their origination. During 2003, 2002 and 2001, the net gain recognized by Key in connection with the ineffective portion of its cash flow hedging instruments was not significant and is included in “other income” on the income statement. Key did not exclude any portions of hedging instruments from the assessment of hedge effectiveness in any of these years.  The change in “accumulated other comprehensive income (loss)” resulting from cash flow hedges is as follows: Reclassifications of gains and losses from “accumulated other comprehensive income (loss)” to earnings coincide with the income statement impact of the hedged item through the payment of variable-rate interest on debt, the receipt of variable-rate interest on commercial loans and the sale or securitization of commercial real estate loans. Key has established a reserve in the amount of $16 million at December 31, 2003, which management believes will be sufficient to cover estimated future losses on the trading portfolio in the event of default. Futures contracts and interest rate swaps, caps and floors. Key uses these instruments for dealer activities, which are generally limited to Key’s commercial loan clients, and enters into positions with third parties that are intended to offset or mitigate the interest rate risk of the client positions. The transactions entered into with clients are generally limited to conventional interest rate swaps. All futures contracts and interest rate swaps, caps and floors are recorded at their estimated fair values. Adjustments to fair value are included in “investment banking and capital markets income” on the income statement. Foreign exchange forward contracts. Key uses these instruments to accommodate the business needs of clients and for proprietary trading purposes. Foreign exchange forward contracts provide for the delayed delivery or purchase of foreign currency. Key mitigates the associated risk by entering into other foreign exchange contracts with third parties. Adjustments to the fair value of all foreign exchange forward contracts are included in “investment banking and capital markets income” on the income statement. Options and futures. Key uses these instruments for proprietary trading purposes. Adjustments to the fair value of options and futures are included in “investment banking and capital markets income” on the income statement.  Swaps and caps present credit risk because the counterparty, which may be a bank or a broker/dealer, may not meet the terms of the contract. This risk is measured as the expected positive replacement value of contracts. To mitigate credit risk, Key deals exclusively with counterparties that have high credit ratings. Key uses two additional means to manage exposure to credit risk on swap contracts. First, Key generally enters into bilateral collateral and master netting arrangements. These agreements provide for the net settlement of all contracts with a single counterparty in the event of default. Second, Key’s Credit Administration department monitors credit risk exposure to the counterparty on each interest rate swap to determine appropriate limits on Key’s total credit exposure and decide whether to demand collateral. If Key determines that collateral is required, it is generally collected at the time this determination is made. Key generally holds collateral in the form of cash and highly rated treasury and agency-issued securities. At December 31, 2003, Key was party to interest rate swaps and caps with 59 different counterparties. Among these were swaps and caps entered into to offset the risk of client exposure. Key had aggregate exposure of $659 million on these instruments to 30 of the counterparties. However, at December 31, Key held approximately $490 million in collateral to mitigate its credit exposure, resulting in net exposure of $169 million. The largest exposure to an individual counterparty was approximately $254 million, of which Key secured approximately $200 million in collateral.  PREVIOUS PAGE SEARCH BACK TO CONTENTS NEXT PAGE 81 ReclassiGLYPH<222>cation December 31, 2003 of Gains to December 31, in millions 2002 Hedging Activity Net Income 2003 Accumulated other comprehensive income  (loss) resulting from cash GLYPH<223>ow hedges $6  $20  $(26) GLYPH<209> TRADING PORTFOLIO  COUNTERPARTY CREDIT RISK