Ally Bank 2014 Annual Report Download - page 152

Table of Contents
Notes to Consolidated Financial Statements
Ally Financial Inc. • Form 10-K
140
Following are descriptions of the valuation methodologies used to measure material assets and liabilities at fair value and details of the
valuation models, key inputs to those models, and significant assumptions utilized.
• Available-for-sale securities — Available-for-sale securities are carried at fair value based on observable market prices, when
available. If observable market prices are not available, our valuations are based on internally developed discounted cash flow
models (an income approach) that use a market-based discount rate and consider recent market transactions, experience with similar
securities, current business conditions, and analysis of the underlying collateral, as available. To estimate cash flows, we are
required to utilize various significant assumptions including market observable inputs (e.g., forward interest rates) and internally
developed inputs (including prepayment speeds, delinquency levels, and credit losses).
• Mortgage loans held-for-sale, net — Certain of our mortgage loans held-for-sale are accounted for at fair value because of fair
value option elections. Mortgage loans held-for-sale are typically pooled together and sold into certain exit markets depending on
underlying attributes of the loan, such as GSE eligibility, product type, interest rate, and credit quality. Mortgage loans classified as
Level 2 as of December 31, 2013 were mainly GSE-eligible mortgage loans carried at fair value due to fair value option election,
which were valued predominantly using published forward agency prices. It also included any domestic loans where recently
negotiated market prices for the loan pool exist with a counterparty (which approximates fair value) or quoted market prices for
similar loans are available. These mortgage loans were transferred into Level 3 as of December 31, 2014 based on decreased
observability of significant inputs resulting from no longer being an active seller of mortgage loans to GSEs. As a result, they are
now valued based on a discounted cash flow basis utilizing cash flow projections from internally developed models that utilized
prepayment, default, and discount rate assumptions.
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.
• 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, options of Eurodollar futures, and equity options. 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 (OTC) and centrally-cleared derivative contracts, such as interest rate swaps, a cross-
currency swap, swaptions, foreign-currency denominated forward contracts, prepaid equity forward contracts, caps, floors, and
agency to-be-announced securities. For OTC contracts, we utilize third-party-developed valuation models that are widely accepted
in the market to value these OTC derivative contracts. The specific terms of the contract and market observable inputs (such as
interest rate forward curves, interpolated volatility assumptions, or equity pricing) are used in the model. We classified these OTC
derivative contracts as Level 2 because all significant inputs into these models were market observable. For centrally-cleared
contracts, we utilize unadjusted prices obtained from the clearing house as the basis for valuation, and they are also classified as
Level 2. During 2014, we began to value our bilateral interest rate swap and interest rate cap portfolio using Overnight Index Swap
discount curves. We previously valued this portfolio using LIBOR discount curves. Because we continued to use a third-party-
developed valuation model in which all significant inputs were market observable, these contracts remained classified as Level 2.
Historically, we had a cross-currency swap and interest rate caps accounted for as derivative instruments that were classified as
Level 3. However, at December 31, 2014, we do not have any positions classified 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 the credit default swap spreads of the counterparty.