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Briefly, management assigns a specific allowance to an impaired loan when the carrying amount of the loan exceeds the estimated present value of related future cash flows and the fair value of any existing collateral. The allowance for loan losses arising from nonimpaired loans is determined by applying historical loss rates to existing loans with similar risk characteristics and by exercising judgment to assess the impact of factors such as changes in economic conditions, credit policies or underwriting standards, and the level of credit risk associated with specific industries and markets. The aggregate balance of the allowance for loan losses at December 31, 2003, represents management’s best estimate of the losses inherent in the loan portfolio at that date. 

The allowance allocated for Key’s impaired loans decreased by $106 million, or 59%, over the past twelve months. This improvement reflects a significant reduction in impaired loans stemming from Key’s continued efforts to resolve problem credits, as well as stabilizing credit quality trends in certain portfolios. 

The level of watch credits in the commercial portfolio has been progressively decreasing since the end of 2002. Watch credits are loans with the potential for further deterioration in quality due to the debtor’s current financial condition and related inability to perform in accordance with the terms of the loan. The commercial loan portfolios with the most significant decreases in watch credits were commercial real estate, large corporate and media. These changes reflect the fluctuations that occur in loan portfolios from time to time, underscoring the benefits of Key’s strategy to limit the concentration of credit risk in any single portfolio. 

As shown in Figure 29, most of the 2003 decrease in Key’s allowance for loan losses was attributable to developments in the commercial loan portfolio. This decrease reflects stabilizing credit quality trends in certain portfolios, as well as weak demand for commercial loans in a soft economy. 

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