Ally Bank 2011 Annual Report Download - page 202

Table of Contents
Notes to Consolidated Financial Statements
Ally Financial Inc. • Form 10−K
market prices were not available. The loans are priced on a discounted cash flow basis utilizing cash flow projections from internally
developed models that utilize prepayment, default, and discount rate assumptions. To the extent available, we will utilize market observable
inputs such as interest rates and market spreads. If market observable inputs are not available, we are required to utilize internal inputs, such
as prepayment speeds, credit losses, and discount rates.
Refer to the section within this note titled Fair Value Option for Financial Assets and Financial Liabilities for further information about the
fair value elections.
Consumer mortgage finance receivables and loans, net — We elected the fair value option for certain consumer mortgage finance receivables
and loans. The elected mortgage loans collateralized on−balance sheet securitization debt in which we estimated credit reserves pertaining to
securitized assets that could have exceeded or already had exceeded our economic exposure. We also elected the fair value option for all
mortgage securitization trusts required to be consolidated due to the adoption of ASU 2009−17. The elected mortgage loans represent a portion
of the consumer finance receivable and loans consolidated upon adoption of ASU 2009−17. The balance for which the fair value option was not
elected was reported on the balance sheet at the principal amount outstanding, net of charge−offs, allowance for loan losses, and premiums or
discounts.
The loans are measured at fair value using a portfolio approach. The objective in fair valuing the loans and related securitization debt is to
account properly for our retained economic interest in the securitizations. As a result of reduced liquidity in capital markets, values of both these
loans and the securitized bonds are expected to be volatile. Since this approach involves the use of significant unobservable inputs, we classified
all the mortgage loans elected under the fair value option as Level 3. Refer to the section within this note titled Fair Value Option of Financial
Assets and Financial Liabilities for additional information.
MSRs — We typically retain MSRs when we sell assets into the secondary market. MSRs are classified as Level 3 because they currently do not
trade in an active market with observable prices; therefore, we use internally developed discounted cash flow models (an income approach) to
estimate the fair value. These internal valuation models estimate net cash flows based on internal operating assumptions that we believe would be
used by market participants combined with market−based assumptions for loan prepayment rates, interest rates, and discount rates that we
believe approximate yields required by investors in this asset. Cash flows primarily include servicing fees, float income, and late fees in each
case less operating costs to service the loans. The estimated cash flows are discounted using an option−adjusted spread−derived discount rate.
Derivative instruments — We enter into a variety of derivative financial instruments as part of our risk management strategies. Certain of these
derivatives are exchange traded, such as Eurodollar futures. To determine the fair value of these instruments, we utilize the quoted market prices
for the particular derivative contracts; therefore, we classified these contracts as Level 1.
We also execute over−the−counter derivative contracts, such as interest rate swaps, swaptions, forwards, caps, floors, and agency
to−be−announced securities. We utilize third−party−developed valuation models that are widely accepted in the market to value these
over−the−counter derivative contracts. The specific terms of the contract and market observable inputs (such as interest rate forward curves and
interpolated volatility assumptions) are used in the model. We classified these over−the−counter derivative contracts as Level 2 because all
significant inputs into these models were market observable.
We also hold certain derivative contracts that are structured specifically to meet a particular hedging objective. These derivative contracts
often are utilized to hedge risks inherent within certain on−balance sheet securitizations. To hedge risks on particular bond classes or
securitization collateral, the derivative's notional amount is often indexed to the hedged item. As a result, we typically are required to use
internally developed prepayment assumptions as an input into the model to forecast future notional amounts on these structured derivative
contracts. Additionally, we hold some foreign currency derivative contracts that utilize an in−house valuation model to determine the fair value
of the contracts. Accordingly, we classified these derivative contracts as Level 3.
We are required to consider all aspects of nonperformance risk, including our own credit standing, when measuring fair value of a liability.
We reduce credit risk on the majority of our derivatives by entering into legally enforceable agreements that enable the posting and receiving of
collateral associated with the fair value of our derivative positions on an ongoing basis. In the event that we do not enter into legally enforceable
agreements that enable the posting and receiving of collateral, we will consider our credit risk and the credit risk of our counterparties in the
valuation of derivative instruments through a credit valuation adjustment (CVA), if warranted. The CVA calculation utilizes our credit default
swap spreads and the spreads of the counterparty.
On−balance sheet securitization debt — We elected the fair value option for certain mortgage loans held−for−investment and the related
on−balance sheet securitization debt. We value securitization debt that was elected pursuant to the fair value option and any economically
retained positions using market observable prices whenever possible. The securitization debt is principally in the form of asset− and MBS
collateralized by the underlying mortgage loans held−for−investment. Due to the attributes of the underlying collateral and current market
conditions, observable prices for these instruments are typically not available. In these situations, we consider observed transactions as Level 2
inputs in our discounted cash flow models. Additionally, the discounted cash flow models utilize other market observable inputs, such as interest
rates, and internally derived inputs including prepayment speeds, credit losses, and discount rates. Fair value option−elected financing
securitization debt is classified as Level 3 as a result of the reliance on significant assumptions and estimates for model inputs. Refer to the
section within this note titled Fair Value Option for Financial Assets and Financial Liabilities for further information about the election. The debt
that was not elected under the fair value option is reported on the balance sheet at cost, net of premiums or discounts and issuance costs.
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