Ally Bank 2012 Annual Report Download - page 178

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internally developed models that utilized prepayment, default, and discount rate assumptions. To the extent available, we
utilized market observable inputs such as interest rates and market spreads. If market observable inputs were not available, we
were 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. The elected mortgage loans represented a
portion of the consumer finance receivables and loans. 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 were measured at fair value using a portfolio approach. The objective in fair valuing the loans and related
securitization debt was 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 were expected to be volatile. Since this approach involved
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 — MSRs are classified as Level 3 because there are limited MSR market transactions that are directly observable; 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 in
orderly transactions 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.
• Interests retained in financial asset sales — The interests retained are in securitization trusts and deferred purchase prices on the
sale of whole-loans. Due to inactivity in the market, valuations are based on internally developed discounted cash flow models (an
income approach) that use a market-based discount rate; therefore, we classified these assets as Level 3. The valuation considers
recent market transactions, experience with similar assets, current business conditions, and analysis of the underlying collateral, as
available. To estimate cash flows, we utilize various significant assumptions, including market observable inputs (e.g., forward
interest rates) and internally developed inputs (e.g., prepayment speeds, delinquency levels, and credit losses).
• 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. 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 valued 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 was 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 were typically not available. In these situations, we
considered observed transactions as Level 2 inputs in our discounted cash flow models. Additionally, the discounted cash flow
models utilized other market observable inputs, such as interest rates, and internally derived inputs including prepayment speeds,
Table of Contents
Notes to Consolidated Financial Statements
Ally Financial Inc. • Form 10-K