Ally Bank 2012 Annual Report Download - page 168

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We enter into economic hedges to mitigate exposure for the following categories.
• MSRs — Our MSRs are generally subject to loss in value when mortgage rates decline. Declining mortgage rates generally result in
an increase in refinancing activity that increases prepayments and results in a decline in the value of MSRs. To mitigate the impact
of this risk, we maintain a portfolio of financial instruments, primarily derivative instruments that increase in value when interest
rates decline. The primary objective is to minimize the overall risk of loss in the value of MSRs due to the change in fair value
caused by interest rate changes.
We may use a multitude of derivative instruments to manage the interest rate risk related to MSRs. They include, but are not
limited to, interest rate futures contracts, call or put options on U.S. Treasuries, swaptions, forward sales of MBS, futures, interest
rate swaps, interest rate floors, and interest rate caps. We monitor and actively manage our risk on a daily basis.
• Mortgage loan commitments and mortgage and automobile loans held-for-sale — We are exposed to interest rate risk from the
time an interest rate lock commitment (IRLC) is made until the time the mortgage loan is sold. Changes in interest rates impact the
market price for our loans; as market interest rates decline, the value of existing IRLCs and loans held-for-sale increase and vice
versa. Our primary objective in risk management activities related to IRLCs and mortgage loans held-for-sale is to eliminate or
greatly reduce any interest rate risk associated with these items.
The primary derivative instrument we use to accomplish the risk management objective for mortgage loans and IRLCs is
forward sales of MBS, primarily Fannie Mae or Freddie Mac to-be-announced securities. These instruments typically are entered
into at the time the IRLC is made. The value of the forward sales contracts moves in the opposite direction of the value of our
IRLCs and mortgage loans held-for-sale. We also use other derivatives, such as interest rate swaps, options, and futures, to
economically hedge automobile loans held-for-sale and certain portions of the mortgage portfolio. Nonderivative instruments, such
as short positions of U.S. Treasuries, may also be periodically used to economically hedge the mortgage portfolio.
• Debt — With the exception of a portion of our fixed-rate debt and a portion of our outstanding floating-rate borrowing associated
with Ally Bank's secured floating-rate credit facility, we do not apply hedge accounting to our derivative portfolio held to mitigate
interest rate risk associated with our debt portfolio. Typically, the significant terms of the interest rate swaps match the significant
terms of the underlying debt resulting in an effective conversion of the rate of the related debt.
• Other — We enter into futures, options, and swaptions to economically hedge our net fixed versus variable interest rate exposure.
We also enter into equity options to economically hedge our exposure to the equity markets.
Foreign Currency Risk
We enter into derivative financial instrument contracts to mitigate the risk associated with variability in cash flows related to foreign-
currency financial instruments. Currency forwards are used to economically hedge foreign exchange exposure on foreign-currency-
denominated debt by converting the funding currency to the same currency of the assets being financed. Similar to our interest rate
derivatives, the derivatives are generally entered into or traded concurrent with the debt issuance with the terms of the derivative matching the
terms of the underlying debt.
Our foreign subsidiaries maintain both assets and liabilities in local currencies; these local currencies are generally the subsidiaries'
functional currencies for accounting purposes. Foreign-currency exchange-rate gains and losses arise when the assets or liabilities of our
subsidiaries are denominated in currencies that differ from its functional currency. In addition, our equity is impacted by the cumulative
translation adjustments resulting from the translation of foreign subsidiary results; this impact is reflected in our accumulated other
comprehensive income (loss). We enter into foreign-currency forwards and option-based contracts with external counterparties to hedge
foreign exchange exposure on our net investments in foreign subsidiaries. In March 2011, we elected to dedesignate all of our existing net
investment hedge relationships and changed our method of measuring hedge effectiveness from the spot method to the forward method for
new hedge relationships entered into prospectively. For the net investment hedges that were designated under the spot method up until
dedesignation date, the hedges were recorded at fair value with changes recorded to accumulated other comprehensive income (loss) with the
exception of the spot to forward difference that was recorded to earnings. For current net investment hedges designated under the forward
method, the hedges are recorded at fair value with the changes recorded to accumulated other comprehensive income (loss) including the spot
to forward difference. The net derivative gain or loss remains in accumulated other comprehensive income (loss) until earnings are impacted
by the sale or the liquidation of the associated foreign operation.
We also have a centralized-lending program to manage liquidity for all of our subsidiary businesses. Foreign-currency-denominated loan
agreements are executed with our foreign subsidiaries in their local currencies. We evaluate our foreign-currency exposure resulting from
intercompany lending and manage our currency risk exposure by entering into foreign-currency derivatives with external counterparties. Our
foreign-currency derivatives are recorded at fair value with changes recorded as income offsetting the gains and losses on the associated
foreign-currency transactions.
We also periodically purchase nonfunctional currency denominated investment securities and enter into foreign-currency forward
contracts with external counterparties to hedge against changes in the fair value of the securities, through maturity, due to changes in the
related foreign-currency exchange rate. The foreign-currency forward contracts are recorded at fair value with changes recorded to earnings.
The changes in value of the securities due to changes in foreign-currency exchange rates are also recorded to earnings. In the case of
Table of Contents
Notes to Consolidated Financial Statements
Ally Financial Inc. • Form 10-K