US Bank 2008 Annual Report Download - page 105

Investments When available, quoted market prices are used
to determine the fair value of investment securities and such
items are classified within Level 1 of the fair value hierarchy.
For other securities, the Company determines fair value
based on various sources and may apply matrix pricing with
observable prices for similar bonds where a price for the
identical bond is not observable. Prices are verified, where
possible, to prices of observable market trades as obtained
from independent sources. Securities measured at fair value
by such methods are classified as Level 2.
For securities for which there are no market trades, the
fair value is based on management’s best estimates. These
securities are categorized as Level 3. For the SIV-related
investments, the majority of the collateral is residential
mortgage-backed securities with the remaining collateral
consisting of commercial mortgage-backed and asset-backed
securities, collateralized debt obligations and collateralized
loan obligations.
The estimation process for Level 3 securities involves
the use of a cash-flow methodology and other market
valuation techniques involving management judgment. The
cash-flow methodology uses assumptions that reflect housing
price changes, interest rates, borrower loan-to-value and
borrower credit scores. Inputs used for estimation are
refined and updated to reflect market developments. The fair
value of these securities are sensitive to changes in the
estimated cash flows and related assumptions used so these
variables are updated on a regular basis. The cash flows are
aggregated and passed through a distribution waterfall to
determine allocation to tranches. Cash flows are discounted
at an interest rate to estimate the fair value of the security
held by the Company. Discount rates reflect current market
conditions including the relative risk and market liquidity of
these investment securities. The primary drivers that impact
the valuations of these securities are the prepayment and
default rates associated with the underlying collateral, as
well as the discount rate used to calculate the present value
of the projected cash flows.
Certain mortgage loans held for sale MLHFS measured at
fair value are initially valued at the transaction price and are
subsequently valued by comparison to instruments with
similar collateral and risk profiles. Included in mortgage
banking revenue for the year ended December 31, 2008, was
$65 million of net losses from the initial measurement and
subsequent changes to fair value of the MLHFS under the
fair value option. Changes in fair value due to instrument
specific credit risk were immaterial. The fair value of
MLHFS was $2.7 billion as of December 31, 2008, which
exceeded the unpaid principal balance by $79 million as of
that date. MLHFS are Level 2. Related interest income for
MLHFS continues to be measured based on contractual
interest rates and reported as interest income in the
Consolidated Statement of Income.
Loans The loan portfolio includes adjustable and fixed-rate
loans, the fair value of which was estimated using
discounted cash flow analyses and other valuation
techniques. To calculate discounted cash flows, the loans
were aggregated into pools of similar types and expected
repayment terms. The expected cash flows of loans
considered historical prepayment experiences and estimated
credit losses for nonperforming loans and were discounted
using current rates offered to borrowers of similar credit
characteristics. Generally loan fair values reflect Level 3
information.
Mortgage servicing rights MSRs are valued using a cash
flow methodology and third party prices, if available.
Accordingly, MSRs are classified in Level 3. Refer to
Note 10 in the Notes to Consolidated Financial Statements
for further information on the methodology used by the
Company in determining the fair value of its MSRs.
Deposit Liabilities The fair value of demand deposits,
savings accounts and certain money market deposits is equal
to the amount payable on demand at year-end. The fair
value of fixed-rate certificates of deposit was estimated by
discounting the contractual cash flow using current rates for
deposits with similar maturities.
Short-term Borrowings Federal funds purchased, securities
sold under agreements to repurchase, commercial paper and
other short-term funds borrowed have floating rates or
short-term maturities. The fair value of short-term
borrowings was determined by discounting contractual cash
flows using current market rates.
Long-term Debt The fair value for most long-term debt was
determined by discounting contractual cash flows using
current market rates. Junior subordinated debt instruments
were valued using market quotes.
Loan Commitments, Letters of Credit and Guarantees The
fair value of commitments, letters of credit and guarantees
represents the estimated costs to terminate or otherwise
settle the obligations with a third-party. The fair value of
residential mortgage commitments is estimated based on
observable inputs. Other loan commitments, letters of credit
and guarantees are not actively traded, and the Company
estimates their fair value based on the related amount of
unamortized deferred commitment fees adjusted for the
probable losses for these arrangements.
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