Ally Bank 2014 Annual Report Download - page 84

Table of Contents
Management's Discussion and Analysis
Ally Financial Inc. • Form 10-K
72
Critical Accounting Estimates
Accounting policies are integral to understanding our Management's Discussion and Analysis of Financial Condition and Results of
Operations. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of
America (GAAP) requires management to make certain judgments and assumptions, on the basis of information available at the time of the
financial statements, in determining accounting estimates used in the preparation of these statements. Our significant accounting policies are
described in Note 1 to the Consolidated Financial Statements; critical accounting estimates are described in this section. An accounting
estimate is considered critical if the estimate requires management to make assumptions about matters that were highly uncertain at the time
the accounting estimate was made. If actual results differ from our judgments and assumptions, then it may have an adverse impact on the
results of operations and cash flows. Our management has discussed the development, selection, and disclosure of these critical accounting
estimates with the Audit Committee of the Board, and the Audit Committee has reviewed our disclosure relating to these estimates.
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 analyses 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 automotive, 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 (automotive 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 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, 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 portfolio segment is primarily composed of larger-balance, nonhomogeneous exposures within our Automotive Finance
operations and Corporate Finance. 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 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,
and geographic information. Management monitors the adequacy of the allowance and makes adjustments as the assumptions in the
underlying analyses change to reflect an estimate of incurred loan losses at the reporting date, based on the best information available at that
time. In addition, the allowance related to the commercial portfolio segment is influenced by estimated recoveries from automotive
manufacturers relative to guarantees or agreements with them to repurchase vehicles used as collateral to secure the loans. If an automotive