Ally Bank 2012 Annual Report Download - page 88

86
models to be reviewed and validated by an independent internal risk group to ensure the models are consistent with their intended use, the
logic within the models is reliable, and the inputs and outputs from these models are appropriate. Additionally, a wide array of operational
controls are in place to ensure the fair value measurements are reasonable, including controls over the inputs into and the outputs from the fair
value measurement models. For example, we backtest the internal assumptions used within models against actual performance. We also
monitor the market for recent trades, market surveys, or other market information that may be used to benchmark model inputs or outputs.
Certain valuations will also be benchmarked to market indices when appropriate and available. We have scheduled model and/or input
recalibrations that occur on a periodic basis but will recalibrate earlier if significant variances are observed as part of the backtesting or
benchmarking noted above.
Considerable judgment is used in forming conclusions from market observable data used to estimate our Level 2 fair value
measurements and in estimating inputs to our internal valuation models used to estimate our Level 3 fair value measurements. Level 3 inputs
such as interest rate movements, prepayment speeds, credit losses, and discount rates are inherently difficult to estimate. Changes to these
inputs can have a significant effect on fair value measurements. Accordingly, our estimates of fair value are not necessarily indicative of the
amounts that could be realized or would be paid in a current market exchange.
Allowance for Loan Losses
We maintain an allowance for loan losses (the allowance) to absorb probable loan credit losses inherent in the held-for-investment
portfolio, excluding those loans measured at fair value in accordance with applicable accounting standards. The allowance is maintained at a
level that management considers to be adequate based upon ongoing quarterly assessments and evaluations of collectability and historical loss
experience in our lending portfolio. The allowance is management's estimate of incurred losses in our lending portfolio and involves
significant judgment. Management performs quarterly analysis of these portfolios to determine if impairment has occurred and to assess the
adequacy of the allowance based on historical and current trends and other factors affecting credit losses. Additions to the allowance are
charged to current period earnings through the provision for loan losses; amounts determined to be uncollectible are charged directly against
the allowance, while amounts recovered on previously charged-off accounts increase the allowance. Determining the appropriateness of the
allowance requires management to exercise significant judgment about matters that are inherently uncertain, including the timing, frequency,
and severity of credit losses that could materially affect the provision for loan losses and, therefore, net income. The methodology for
determining the amount of the allowance differs between the consumer automobile, consumer mortgage, and commercial portfolio segments.
For additional information regarding our portfolio segments and classes, refer to Note 8 to the Consolidated Financial Statements. While we
attribute portions of the allowance across our lending portfolios, the entire allowance is available to absorb probable loan losses inherent in
our total lending portfolio.
The consumer portfolio segments consist of smaller-balance, homogeneous loans. Excluding certain loans that are identified as
individually impaired, the allowance for each consumer portfolio segment (automobile and mortgage) is evaluated collectively. The allowance
is based on aggregated portfolio segment evaluations that begin with estimates of incurred losses in each portfolio segment based on various
statistical analyses. We leverage proprietary statistical models, including vintage and migration analyses, based on recent loss trends, to
develop a systematic incurred loss reserve. These statistical loss forecasting models are utilized to estimate incurred losses and consider
several credit quality indicators including, but not limited to, historical loss experience, estimated foreclosures or defaults based on observable
trends, delinquencies, and general economic and business trends. Management believes these factors are relevant to estimate incurred losses
and are updated on a quarterly basis in order to incorporate information reflective of the current economic environment, as changes in these
assumptions could have a significant impact. In order to develop our best estimate of probable incurred losses inherent in the loan portfolio,
management reviews and analyzes the output from the models and may adjust the reserves to take into consideration environmental,
qualitative and other factors that may not be captured in the models. These adjustments are documented and reviewed through our risk
management processes. Management reviews, updates, and validates its systematic process and loss assumptions on a periodic basis. This
process involves an analysis of loss information, such as a review of loss and credit trends, a retrospective evaluation of actual loss
information to loss forecasts, and other analyses.
The commercial loan portfolio segment is primarily composed of larger-balance, nonhomogeneous exposures within our Automotive
Finance operations, Commercial Finance Group, and Mortgage operations. As of December 31, 2012, we no longer have any commercial
loans within our mortgage operations. These loans are primarily evaluated individually and are risk-rated based on borrower, collateral, and
industry-specific information that management believes is relevant in determining the occurrence of a loss event and measuring impairment.
A loan is considered impaired when it is probable that we will be unable to collect all amounts due according to the contractual terms of the
loan agreement based on current information and events. Management establishes specific allowances for commercial loans determined to be
individually impaired based on the present value of expected future cash flows, discounted at the loans' effective interest rate, observable
market price or the fair value of collateral, whichever is determined to be the most appropriate. Estimated costs to sell or realize the value of
the collateral on a discounted basis are included in the impairment measurement, when appropriate. In addition to the specific allowances for
impaired loans, loans that are not identified as individually impaired are grouped into pools based on similar risk characteristics and
collectively evaluated. These allowances are based on historical loss experience, concentrations, current economic conditions, and
performance trends within specific geographic locations. The commercial historical loss experience is updated quarterly to incorporate the
most recent data reflective of the current economic environment.
The determination of the allowance is influenced by numerous assumptions and many factors that may materially affect estimates of
loss, including volatility of loss given default, probability of default, and rating migration. The critical assumptions underlying the allowance
include: (1) segmentation of each portfolio based on common risk characteristics; (2) identification and estimation of portfolio indicators and
other factors that management believes are key to estimating incurred credit losses; and (3) evaluation by management of borrower, collateral,
Table of Contents
Management's Discussion and Analysis
Ally Financial Inc. • Form 10-K