Comerica 2014 Annual Report Download - page 88

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Comerica Incorporated and Subsidiaries
F-51
Derivative assets and derivative liabilities
Derivative instruments held or issued for risk management or customer-initiated activities are traded in over-the-counter
markets where quoted market prices are not readily available. Fair value for over-the-counter derivative instruments is measured
on a recurring basis using internally developed models that use primarily market observable inputs, such as yield curves and
option volatilities. The Corporation manages credit risk on its derivative positions based on whether the derivatives are being
settled through a clearinghouse or bilaterally with each counterparty. For derivative positions settled on a counterparty-by-
counterparty basis, the Corporation calculates credit valuation adjustments, included in the fair value of these instruments, on
the basis of its relationships at the counterparty portfolio/master netting agreement level. These credit valuation adjustments
are determined by applying a credit spread for the counterparty or the Corporation, as appropriate, to the total expected exposure
of the derivative after considering collateral and other master netting arrangements. These adjustments, which are considered
Level 3 inputs, are based on estimates of current credit spreads to evaluate the likelihood of default. The Corporation assessed
the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and
determined that the credit valuation adjustments were not significant to the overall valuation of its derivatives. As a result,
the Corporation classifies its over-the-counter derivative valuations in Level 2 of the fair value hierarchy. Examples of Level
2 derivative instruments are interest rate swaps and energy derivative and foreign exchange contracts.
Warrants which contain a net exercise provision or a non-contingent put right embedded in the warrant agreement are accounted
for as derivatives and recorded at fair value on a recurring basis using a Black-Scholes valuation model. The Black-Scholes
valuation model utilizes five inputs: risk-free rate, expected life, volatility, exercise price, and the per share market value of
the underlying company. The Corporation holds a portfolio of warrants for generally nonmarketable equity securities with a
fair value of $4 million at December 31, 2014, included in "accrued income and other assets" on the consolidated balance
sheets. These warrants are primarily from non-public technology companies obtained as part of the loan origination process.
The Corporate Development Department is responsible for the warrant valuation process, which includes reviewing all
significant inputs for reasonableness, and for providing valuation results to senior management. Increases in any of these
inputs in isolation, with the exception of exercise price, would result in a higher fair value. Increases in exercise price in
isolation would result in a lower fair value. The Corporation classifies warrants accounted for as derivatives as Level 3.
The Corporation also holds a derivative contract associated with the 2008 sale of its remaining ownership of Visa Inc. (Visa)
Class B shares. Under the terms of the derivative contract, the Corporation will compensate the counterparty primarily for
dilutive adjustments made to the conversion factor of the Visa Class B to Class A shares based on the ultimate outcome of
litigation involving Visa. Conversely, the Corporation will be compensated by the counterparty for any increase in the
conversion factor from anti-dilutive adjustments. At December 31, 2014, the fair value of the contract was a liability of
$1 million. The recurring fair value of the derivative contract is based on unobservable inputs consisting of management's
estimate of the litigation outcome, timing of litigation settlements and payments related to the derivative. Significant increases
in the estimate of litigation outcome and the timing of litigation settlements in isolation would result in a significantly higher
liability fair value. Significant increases in payments related to the derivative in isolation would result in a significantly lower
liability fair value. The Corporation classifies the derivative liability as Level 3.
Nonmarketable equity securities
The Corporation has a portfolio of indirect (through funds) private equity and venture capital investments with a carrying
value and unfunded commitments of $11 million and $5 million, respectively, at December 31, 2014. These funds generally
cannot be redeemed and the majority is not readily marketable. Distributions from these funds are received by the Corporation
as a result of the liquidation of underlying investments of the funds and/or as income distributions. It is estimated that the
underlying assets of the funds will be liquidated over a period of up to 15 years. Recently issued federal regulations will
require the Corporation to sell certain of these funds prior to liquidation. The investments are accounted for either on the cost
or equity method and are individually reviewed for impairment on a quarterly basis by comparing the carrying value to the
estimated fair value. These investments may be carried at fair value on a nonrecurring basis when they are deemed to be
impaired and written down to fair value. Where there is not a readily determinable fair value, the Corporation estimates fair
value for indirect private equity and venture capital investments based on the net asset value, as reported by the fund, after
indication that the fund adheres to applicable fair value measurement guidance. On a quarterly basis, the Corporate Development
Department is responsible, with appropriate oversight and approval provided by senior management, for performing the
valuation procedures and updating significant inputs, as are primarily provided by the underlying fund's management. The
Corporation classifies fair value measurements of nonmarketable equity securities as Level 3.
The Corporation also holds restricted equity investments, primarily Federal Home Loan Bank (FHLB) and Federal Reserve
Bank (FRB) stock. Restricted equity securities are not readily marketable and are recorded at cost (par value) in "accrued
income and other assets" on the consolidated balance sheets and evaluated for impairment based on the ultimate recoverability
of the par value. No significant observable market data for these instruments is available. The Corporation considers the