assets are reported at fair value ($1.0 billion at December 31, 2003, and $801 million at December 31, 2002) and are included in “short-term investments” on the balance sheet. Realized and unrealized gains and losses on trading account securities are reported in “investment banking and capital markets income” on the income statement. 

Securities available for sale. These are securities that Key intends to hold for an indefinite period of time and that may be sold in response to changes in interest rates, prepayment risk, liquidity needs or other factors. Securities available for sale are reported at fair value and include debt and marketable equity securities with readily determinable fair values. Unrealized gains and losses (net of income taxes) deemed temporary are recorded in shareholders’ equity as a component of “accumulated other comprehensive income (loss).” Unrealized losses on specific securities deemed to be “other-than-temporary” are included in “net securities gains” on the income statement. Additional information regarding unrealized gains and losses on debt and marketable equity securities with readily determinable fair values is included in Note 6 (“Securities”), which begins on page 61. Also included in “net securities gains” are actual gains and losses resulting from sales of specific securities. 

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

Other investments. Principal investments — investments in equity and mezzanine instruments made by Key’s Principal Investing unit — represent the majority of other investments and are carried at fair value ($732 million at December 31, 2003, and $677 million at December 31, 2002). They include direct and indirect investments predominately in privately held companies. Direct investments are those made in a particular company, while indirect investments are made through funds that include other investors. Changes in estimated fair values and actual gains and losses on sales of principal investments are included in “investment banking and capital markets income” on the income statement. 

In addition to principal investments, other investments include equity and mezzanine instruments that do not have readily determinable fair values. These securities include certain real estate-related investments that are carried at estimated fair value, as well as other types of securities that are generally carried at cost. The carrying amount of the securities carried at cost is adjusted for declines in value that are considered to be “other than temporary.” These adjustments are included in “net securities gains”on the income statement. 

## LOANS 

Loans are carried at the principal amount outstanding, net of unearned income, including net deferred loan fees and costs. Key defers certain nonrefundable loan origination and commitment fees and the direct costs of originating or acquiring loans. The net deferred amount is amortized over the estimated lives of the related loans as an adjustment to the yield. 

At December 31, 2003, loans held for sale include mortgage and education loans. These loans are carried at the lower of aggregate cost or fair value. Fair value is determined based on prevailing market prices for loans with similar characteristics. When a loan is placed in the held for sale category, amortization of the related deferred fees and costs is discontinued. The remaining unamortized fees and costs are recognized as part of the cost basis of the loan at the time it is sold. 

Direct financing leases are carried at the aggregate of lease payments receivable plus estimated residual values, less unearned income. Unearned income on direct financing leases is amortized over the lease terms using methods that approximate the interest method. This method amortizes unearned income to produce a constant rate of return on the lease. Net gains or losses on sales of lease residuals are included in “other income” on the income statement. 

## IMPAIRED AND OTHER NONACCRUAL LOANS 

Key will generally stop accruing interest on a loan (i.e., designate the loan “nonaccrual”) when the borrower’s payment is 90 days or more past due, unless the loan is well-secured and in the process of collection. Loans are also placed on nonaccrual status when payment is not past due but management has serious doubts as to the ability of the borrower to comply with existing loan repayment terms. Once a loan is designated as nonaccrual, the interest accrued but not collected is generally charged against the allowance for loan losses, and payments subsequently received are generally applied to principal. However, if management believes that all principal and interest on a nonaccrual loan ultimately are collectible, interest income may be recognized as received. 

Nonaccrual loans, other than smaller-balance homogeneous loans (i.e., loans to finance residential mortgages, automobiles, etc.), are designated “impaired.” Impaired loans and other nonaccrual loans are returned to accrual status when management determines that the borrower’s performance has improved and that both principal and interest are collectible. This generally requires a sustained period of timely principal and interest payments. 

## ALLOWANCE FOR LOAN LOSSES 

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio at the balance sheet date. Key determines and maintains an appropriate allowance for loan losses based on an analysis of the quality of the loan portfolio. This analysis is conducted at least quarterly, and more often if deemed necessary. 

Allowance for impaired loans. When expected cash flows or collateral values do not justify the carrying amount of an impaired loan, the loan is assigned a specific allowance. Management calculates the extent of the impairment, which is the carrying amount of the loan less the estimated present value of future cash flows and the fair value of any existing collateral. The amount that management deems uncollectible (the impaired amount) is charged against the allowance for loan losses. Even when collateral value or other sources of repayment appear sufficient, if management remains uncertain about whether the loan will be repaid in full, an appropriate amount is specifically allocated in the allowance for loan losses. 

