Ally Bank 2012 Annual Report Download - page 90

88
We use the following key assumptions in our valuation approach.
• Prepayment — The most significant drivers of mortgage servicing rights value are actual and forecasted portfolio prepayment
behavior. Prepayment speeds represent the rate at which borrowers repay their mortgage loans prior to scheduled maturity.
Prepayment speeds are influenced by a number of factors such as the value of collateral, competitive market factors, government
programs or incentives, or levels of foreclosure activity. However, the most significant factor influencing prepayment speeds is
generally the interest rate environment. As interest rates rise, prepayment speeds generally slow, and as interest rates decline,
prepayment speeds generally accelerate. When mortgage loans are paid or expected to be paid earlier than originally estimated, the
expected future cash flows associated with servicing such loans are reduced. We primarily use third-party models to project
residential mortgage loan payoffs. In other cases, we estimate prepayment speeds based on historical and expected future
prepayment rates. We measure model performance by comparing prepayment predictions against actual results at both the portfolio
and product level.
• Discount rate — The cash flows of our mortgage servicing rights are discounted at prevailing market rates, which include an
appropriate risk-adjusted spread, which management believes approximates yields required by investors for these assets.
• Base mortgage rate — The base mortgage rate represents the current market interest rate for newly originated mortgage loans. This
rate is a key component in estimating prepayment speeds of our portfolio because the difference between the current base mortgage
rate and the interest rates on existing loans in our portfolio is an indication of the borrower's likelihood to refinance.
• Cost to service — In general, servicing cost assumptions are based on internally projected actual expenses directly related to
servicing. These servicing cost assumptions are compared to market-servicing costs when market information is available. Our
servicing cost assumptions include expenses associated with our activities related to loans in default.
• Volatility — Volatility represents the expected rate of change of interest rates. The volatility assumption used in our valuation
methodology is intended to estimate the range of expected outcomes of future interest rates. We use implied volatility assumptions
in connection with the valuation of our mortgage servicing rights. Implied volatility is defined as the expected rate of change in
interest rates derived from the prices at which options on interest rate swaps, or swaptions, are trading. We update our volatility
assumptions for the change in implied swaptions volatility during the period, adjusted by the ratio of historical mortgage to
swaption volatility.
We also periodically perform a series of reasonableness tests as we deem appropriate, including the following.
• Review and compare data provided by an independent third-party broker. We evaluate and compare our fair value price, multiples,
and underlying assumptions to data provided by independent third-party broker, including prepayment speeds, discount rates, cost
to service, and fair value multiples.
• Review and compare pricing of publicly traded interest-only securities. We evaluate and compare our fair value to publicly traded
interest-only stripped MBS by age and coupon for reasonableness.
• Review and compare fair value price and multiples. We evaluate and compare our fair value price and multiples to market fair
value price and multiples in external surveys produced by third parties.
• Compare actual monthly cash flows to projections. We reconcile actual monthly cash flows to those projected in the mortgage
servicing rights valuation. Based on the results of this reconciliation, we assess the need to modify the individual assumptions used
in the valuation. This process ensures the model is calibrated to actual servicing cash flow results.
• Review and compare recent bulk mortgage servicing right acquisition activity. We evaluate market trades for reliability and
relevancy and then consider, as appropriate, our estimate of fair value of each significant transaction to the traded price. Currently,
there are limited market transactions that are directly observable, which are the best indicators of fair value. However, we continue
to monitor and track market activity on an ongoing basis.
We generally expect our valuation to be within a reasonable range of that implied by these tests. Changes in these assumptions could
have a significant impact on the determination of fair market value. In order to develop our best estimate of fair value, management reviews
and analyzes the output from the models and may adjust the assumptions to take into consideration other factors that may not be captured. If
we determine our valuation has exceeded the reasonable range, we may adjust it accordingly. At December 31, 2012, based on the market
information obtained, we determined that our mortgage servicing rights valuations and assumptions used to value those servicing rights were
reasonable and consistent with what an independent market participant would use to value the asset.
The assumptions used in modeling expected future cash flows of mortgage servicing rights have a significant impact on the fair value of
mortgage servicing rights and potentially a corresponding impact to earnings. Refer to Note 11 to the Consolidated Financial Statements for
sensitivity analysis.
Table of Contents
Management's Discussion and Analysis
Ally Financial Inc. • Form 10-K