Wells Fargo 2013 Annual Report Download - page 234

Note 17: Fair Values of Assets and Liabilities (continued)
instrument for a given change in that input. Alternatively, the
fair value of the instrument may move in an opposite direction
for a given change in another input. Where multiple inputs are
used within the valuation technique of an asset or liability, a
change in one input in a certain direction may be offset by an
opposite change in another input having a potentially muted
impact to the overall fair value of that particular instrument.
Additionally, a change in one unobservable input may result in a
change to another unobservable input (that is, changes in certain
inputs are interrelated to one another), which may counteract or
magnify the fair value impact.
SECURITIES, LOANS and MORTGAGES HELD FOR SALE The
fair values of predominantly all Level 3 trading securities,
mortgages held for sale, loans, other nonmarketable equity
investments, and available-for-sale securities have consistent
inputs, valuation techniques and correlation to changes in
underlying inputs. The internal models used to determine fair
value for these Level 3 instruments use certain significant
unobservable inputs within a discounted cash flow or market
comparable pricing valuation technique. Such inputs include
discount rate, prepayment rate, default rate, loss severity,
utilization rate and weighted average life.
These Level 3 assets would decrease (increase) in value based
upon an increase (decrease) in discount rate, default rate, loss
severity, or weighted average life inputs. Conversely, the fair
value of these Level 3 assets would generally increase (decrease)
in value if the prepayment rate input were to increase (decrease)
or if the utilization rate input were to increase (decrease).
Generally, a change in the assumption used for default rate is
accompanied by a directionally similar change in the risk
premium component of the discount rate (specifically, the
portion related to credit risk) and a directionally opposite change
in the assumption used for prepayment rates. Unobservable
inputs for loss severity, utilization rate and weighted average life
do not increase or decrease based on movements in the other
significant unobservable inputs for these Level 3 assets.
DERIVATIVE INSTRUMENTS Level 3 derivative instruments
are valued using market comparable pricing, option pricing and
discounted cash flow valuation techniques. We utilize certain
unobservable inputs within these techniques to determine the
fair value of the Level 3 derivative instruments. The significant
unobservable inputs consist of credit spread, a comparability
adjustment, prepayment rate, default rate, loss severity, initial-
value servicing, fall-out factor, volatility factor, weighted average
life, conversion factor, and correlation factor.
Level 3 derivative assets (liabilities) where we are long the
underlying would decrease (increase) in value upon an increase
(decrease) in default rate, fall-out factor, credit spread,
conversion factor, or loss severity inputs. Conversely, Level 3
derivative assets (liabilities) would increase (decrease) in value
upon an increase (decrease) in prepayment rate, initial-value
servicing, weighted average life, or volatility factor inputs. The
inverse of the above relationships would occur for instruments in
which we are short the underlying. The correlation factor and
comparability adjustment inputs may have a positive or negative
impact on the fair value of these derivative instruments
depending on the change in value of the item the correlation
factor and comparability adjustment is referencing. The
correlation factor and comparability adjustment is considered
independent from movements in other significant unobservable
inputs for derivative instruments.
Generally, for derivative instruments for which we are subject
to changes in the value of the underlying referenced instrument,
change in the assumption used for default rate is accompanied
by directionally similar change in the risk premium component
of the discount rate (specifically, the portion related to credit
risk) and a directionally opposite change in the assumption used
for prepayment rates. Unobservable inputs for loss severity, fall-
out factor, initial-value servicing, weighted average life,
conversion factor, and volatility do not increase or decrease
based on movements in other significant unobservable inputs for
these Level 3 instruments.
MORTGAGE SERVICING RIGHTS We use a discounted cash
flow valuation technique to determine the fair value of Level 3
mortgage servicing rights. These models utilize certain
significant unobservable inputs including prepayment rate,
discount rate and costs to service. An increase in any of these
unobservable inputs will reduce the fair value of the mortgage
servicing rights and alternatively, a decrease in any one of these
inputs would result in the mortgage servicing rights increasing in
value. Generally, a change in the assumption used for the default
rate is accompanied by a directionally similar change in the
assumption used for cost to service and a directionally opposite
change in the assumption used for prepayment. The sensitivity
of our residential MSRs is discussed further in Note 8.
232