Wells Fargo 2014 Annual Report Download - page 230

Note 17: Fair Values of Assets and Liabilities (continued)
Significant Recurring Level 3 Fair Value Asset and
Liability Input Sensitivity
We generally use discounted cash flow or similar internal
modeling techniques to determine the fair value of our Level 3
assets and liabilities. Use of these techniques requires
determination of relevant inputs and assumptions, some of
which represent significant unobservable inputs as indicated in
the preceding tables. Accordingly, changes in these unobservable
inputs may have a significant impact on fair value.
Certain of these unobservable inputs will (in isolation) have
a directionally consistent impact on the fair value of the
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, MORTGAGES HELD FOR SALE and
NONMARKETABLE EQUITY INVESTMENTS 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, comparability
adjustment 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
(Securitizations and Variable Interest Entities).
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