Capital One 2013 Annual Report Download - page 261

CAPITAL ONE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Net Loans Held For Investment
Loans held for investment that are individually impaired are carried at the lower of cost or fair value of the
underlying collateral, less the estimated cost to sell. The fair values of credit card loans, installment loans, auto
loans, home loans and commercial loans were estimated using a discounted cash flow method, a form of the
income approach. Discount rates were determined considering rates at which similar portfolios of loans would be
made under current conditions and considering liquidity spreads applicable to each loan portfolio based on the
secondary market. The fair value of credit card loans excluded any value related to customer account
relationships.
Due to the use of unobservable inputs, loans held for investment are classified as Level 3 under the fair value
hierarchy. Fair value adjustments for loans held for investment are recorded in provision for credit losses in the
consolidated statement of income. The fair value of these loans as of December 31, 2013 remained substantially
unchanged compared to the previous year as the impact of higher market rates was offset by improved credit
performance in our card, mortgage and commercial loan portfolios.
Interest Receivable
The carrying amount of interest receivable approximates the fair value of this asset due to its relatively
short-term nature.
Derivative Assets and Liabilities
We use both exchange-traded derivatives and over-the-counter (“OTC”) derivatives to manage our interest rate
and foreign currency risk exposure. Quoted market prices are available and used for our exchange-traded
derivatives, which we classify as Level 1. However, substantially all of our derivatives are traded in OTC
markets where quoted market prices are not always readily available. Therefore, we value most OTC derivatives
using valuation techniques, which include internally-developed models. We primarily rely on market observable
inputs for our models, such as interest rate yield curves, credit curves, option volatility and currency rates, that
vary depending on the type of derivative and nature of the underlying rate, price or index upon which the
derivative’s value is based. Where model inputs can be observed in a liquid market and the model does not
require significant judgment, such derivatives are typically classified as Level 2 of the fair value hierarchy. When
instruments are traded in less liquid markets and significant inputs are unobservable, such as interest rate swaps
whose remaining terms do not correlate with market observable interest rate yield curves, the derivatives are
classified as Level 3.
The impact of counterparty non-performance risk is considered when measuring the fair value of derivative
assets. These derivatives are included in other assets on the balance sheet.
We validate the pricing obtained from the internal models through comparison of pricing to additional sources,
including external valuation agents and other internal sources. Pricing variances among different pricing sources
are analyzed and validated.
Mortgage Servicing Rights
We record consumer MSRs at fair value on a recurring basis, while commercial MSRs are subsequently
measured at amortized cost with impairment recognized as a reduction in other non-interest income. MSRs do
not trade in an active market with readily observable prices. Accordingly, we determine the fair value of MSRs
using a valuation model that calculates the present value of estimated future net servicing income. The model
241