Capital One 2011 Annual Report Download - page 172

CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED STATEMENTS—(Continued)
hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or
unobservable. Fair value measurement of a financial asset or liability is assigned to a level based on the lowest
level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value
hierarchy are described below:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2: Observable market-based inputs, other than quoted prices in active markets for identical assets
or liabilities.
Level 3: Unobservable inputs.
Under the fair value accounting guidance, an entity has the irrevocable option to elect, on a contract-by-contract
basis, to measure certain financial assets and liabilities at fair value at inception of the contract and thereafter,
with any changes in fair value recorded in current earnings. We did not make any material fair value
option elections as of and for the years ended December 31, 2011 and 2010. See “Note 19—Fair Value of
Financial Instruments” for additional information.
Representation and Warranty Reserve
In connection with their sales of mortgage loans, our subsidiaries entered into agreements containing varying
representations and warranties about, among other things, the ownership of the loan, the validity of the lien
securing the loan, the loan’s compliance with any applicable loan criteria established by the purchaser, including
underwriting guidelines and the ongoing existence of mortgage insurance, and the loan’s compliance with
applicable federal, state and local laws. We may be required to repurchase the mortgage loan, indemnify the
investor or insurer, or reimburse the investor for credit losses incurred on the loan in the event of a material
breach of contractual representations or warranties.
We have established representation and warranty reserves for losses that we consider to be both probable and
reasonably estimable associated with the mortgage loans sold by each subsidiary, including both litigation and
non-litigation liabilities. The reserve-setting process relies heavily on estimates, which are inherently uncertain,
and requires the application of judgment. In establishing the representation and warranty reserves, we consider a
variety of factors, depending on the category of purchaser and rely on historical data. We evaluate these
estimates on a quarterly basis.
Losses incurred on loans that we are required to either repurchase or make payments to the investor under the
indemnification provisions are charged against the reserve. The representation and warranty reserve is included
in other liabilities. Changes to the representation and warranty reserve related to GreenPoint are reported as
discontinued operations for all periods presented. See “Note 21—Commitments, Contingencies and Guarantees”
for additional information related to our representation and warranty reserve.
Rewards Liability
We offer products, primarily credit cards, that offer reward program members with various rewards, such as
airline tickets, cash, or merchandise, based on account activity. We generally recognize rewards cost as an offset
to interchange income when the rewards are earned by the customer and record the corresponding rewards
liability. The rewards liability is computed based on points earned to date that are expected to be redeemed and
the average cost per point redemption. The rewards liability is reduced as points are redeemed. In estimating the
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