Capital One 2008 Annual Report Download - page 52

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For other consumer loans and commercial loans, the Company places loans in a non-accrual status, which prevents the accrual of
further interest income, when a loan reaches a pre-determined delinquency status, generally 90 to 120 days past due.
At the time a loan is placed on nonaccrual status, interest and fees accrued but not collected through the end of the previous quarter are
systematically reversed and charged against income. Interest payments received on nonaccrual loans are applied to principal if there is
doubt as to the collectibility of the principal; otherwise, these receipts are recorded as interest income. A loan remains in nonaccrual
status until it is current as to principal and interest and the borrower demonstrates the ability to fulfill the contractual obligation.
Upon foreclosure or repossession, loans are adjusted, if necessary, to the estimated fair value of the underlying collateral and
transferred to other assets, net of a valuation allowance for selling costs. We estimate market values primarily based on appraisals
when available or quoted market prices on liquid assets.
Valuation of Mortgage Servicing Rights
Mortgage servicing rights (MSRs) are recognized at fair value when mortgage loans are sold in the secondary market and the right
to service these loans are retained for a fee; changes in fair value are recognized in mortgage servicing and other income. The
Company continues to operate the mortgage servicing business and to report the changes in the fair value of MSRs in continuing
operations. To evaluate and measure fair value, the underlying loans are stratified based on certain risk characteristics, including loan
type, note rate and investor servicing requirements. Fair value of the MSRs is determined using the present value of the estimated
future cash flows of net servicing income. The Company uses assumptions in the valuation model that market participants use when
estimating future net servicing income, including prepayment speeds, discount rates, default rates, cost to service, escrow account
earnings, contractual servicing fee income, ancillary income and late fees. This model is highly sensitive to changes in certain
assumptions. Different anticipated prepayment speeds, in particular, can result in substantial changes in the estimated fair value of
MSRs. If actual prepayment experience differs from the anticipated rates used in the Companys model, this difference could result in
a material change in MSR value.
As of December 31 2008 and 2007, the MSR balance was $150.5 million and $247.6 million, respectively.
Valuation of Representation and Warranty Reserve
The representation and warranty reserve is available to cover probable losses inherent with the sale of mortgage loans in the secondary
market. In the normal course of business, certain representations and warranties are made to investors at the time of sale, which permit
the investor to return the loan to the seller or require the seller to indemnify the investor for certain losses incurred by the investor
while the loan remains outstanding. The evaluation process for determining the adequacy of the representation and warranty reserve
and the periodic provisioning for estimated losses is performed for each product type on a quarterly basis. Factors considered in the
evaluation process include historical sales volumes, aggregate repurchase and indemnification activity, and actual losses incurred.
Quarterly changes to the representation and warranty reserve related to GreenPoint are reported as discontinued operations for all
periods presented.
As of December 31, 2008 and 2007, the representation and warranty reserve was $140.2 million and $93.4 million, respectively, of
which $122.2 million and $84.5 million were attributable to the discontinued wholesale mortgage origination business of GreenPoint,
respectively.
Valuation of Retained Interests in Securitization Transactions
The Companys retained residual interests in off-balance sheet securitizations are recorded in accounts receivable from securitizations
and are comprised of interest-only strips, retained senior tranches, retained subordinated tranches, cash collateral accounts, cash
reserve accounts and unpaid interest and fees on the investors portion of the transferred principal receivables.
In accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
(SFAS 140), the Company removes loan receivables from its Consolidated Balance Sheet and records a gain on sale for
securitization transactions that qualify as sales (off-balance sheet securitizations). The gain is recorded net of transaction costs and is
based on the estimated fair value of the assets sold and assets retained or liabilities incurred. The related receivable is the interest-only
strip, which is based on the present value of the estimated future cash flows from excess finance charges and past-due fees over the
sum of the return paid to security holders, estimated contractual servicing fees and credit losses. Retained assets are recorded in
accounts receivable from securitizations at estimated fair value. The Companys retained residual interests are generally restricted or
subordinated to investors interests and their value is subject to substantial credit, repayment and interest rate risks on transferred
assets if the off-balance sheet loans are not paid when due. As such, the interest-only strip and subordinated retained interests are
classified as trading assets in accordance with SFAS No. 155, Accounting for Certain Hybrid Financial Instrumentsan amendment
of FASB Statements No. 133 and 140 (SFAS 155), and changes in the estimated fair value are recorded in servicing and
securitization income. Additionally, the Company may retain senior tranches in the securitization transactions which are considered to