US Bank 2012 Annual Report Download - page 72

rates for this segment of the loan portfolio increased by
10 percent, the allowance for credit losses would increase by
approximately $168 million at December 31, 2012. Because
several quantitative and qualitative factors are considered in
determining the allowance for credit losses, these sensitivity
analyses do not necessarily reflect the nature and extent of
future changes in the allowance for credit losses. They are
intended to provide insights into the impact of adverse
changes in risk rating and inherent losses and do not imply
any expectation of future deterioration in the risk rating or
loss rates. Given current processes employed by the Company,
management believes the risk ratings and inherent loss rates
currently assigned are appropriate. It is possible that others,
given the same information, may at any point in time reach
different reasonable conclusions that could be significant to
the Company’s financial statements. Refer to the “Analysis
and Determination of the Allowance for Credit Losses”
section for further information.
Fair Value Estimates A portion of the Company’s assets and
liabilities are carried at fair value on the Consolidated Balance
Sheet, with changes in fair value recorded either through
earnings or other comprehensive income (loss) in accordance
with applicable accounting principles generally accepted in the
United States. These include all of the Company’s available-
for-sale securities, derivatives and other trading instruments,
MSRs and most mortgage loans held for sale. The estimation
of fair value also affects other loans held for sale, which are
recorded at the lower-of-cost-or-fair value. The determination
of fair value is important for certain other assets that are
periodically evaluated for impairment using fair value
estimates including goodwill and other intangible assets,
impaired loans, other real estate owned and other repossessed
assets.
Fair value is generally defined as the exit price at which
an asset or liability could be exchanged in a current
transaction between willing, unrelated parties, other than in a
forced or liquidation sale. Fair value is based on quoted
market prices in an active market, or if market prices are not
available, is estimated using models employing techniques
such as matrix pricing or discounting expected cash flows.
The significant assumptions used in the models, which include
assumptions for interest rates, discount rates, prepayments
and credit losses, are independently verified against observable
market data where possible. Where observable market data is
not available, the estimate of fair value becomes more
subjective and involves a high degree of judgment. In this
circumstance, fair value is estimated based on management’s
judgment regarding the value that market participants would
assign to the asset or liability. This valuation process takes
into consideration factors such as market illiquidity.
Imprecision in estimating these factors can impact the amount
recorded on the balance sheet for a particular asset or liability
with related impacts to earnings or other comprehensive
income (loss).
When available, trading and available-for-sale securities
are valued based on quoted market prices. However, certain
securities are traded less actively and therefore, quoted market
prices may not be available. The determination of fair value
may require benchmarking to similar instruments or
performing a discounted cash flow analysis using estimates of
future cash flows and prepayment, interest and default rates.
An example is non-agency residential mortgage-backed
securities. For more information on investment securities,
refer to Note 4 of the Notes to Consolidated Financial
Statements.
As few derivative contracts are listed on an exchange, the
majority of the Company’s derivative positions are valued
using valuation techniques that use readily observable market
inputs. Certain derivatives, however, must be valued using
techniques that include unobservable inputs. For these
instruments, the significant assumptions must be estimated
and therefore, are subject to judgment. Note 19 of the Notes
to Consolidated Financial Statements provides a summary of
the Company’s derivative positions.
Refer to Note 20 of the Notes to Consolidated Financial
Statements for additional information regarding estimations
of fair value.
Purchased Loans and Related Indemnification Assets In
accordance with applicable authoritative accounting guidance
effective for the Company beginning January 1, 2009, all
purchased loans and related indemnification assets arising
from loss-sharing arrangements with the FDIC are recorded at
fair value at date of purchase. The initial valuation of these
loans and the related indemnification assets requires
management to make subjective judgments concerning
estimates about how the acquired loans will perform in the
future using valuation methods including discounted cash
flow analysis and independent third party appraisals. Factors
that may significantly affect the initial valuation include,
among others, market-based and industry data related to
expected changes in interest rates, assumptions related to
probability and severity of credit losses, estimated timing of
credit losses including the foreclosure and liquidation of
collateral, expected prepayment rates, required or anticipated
loan modifications, unfunded loan commitments, the specific
terms and provisions of any loss sharing agreements, and
specific industry and market conditions that may impact
discount rates and independent third party appraisals.
On an ongoing basis, the accounting for purchased loans
and related indemnification assets follows applicable
authoritative accounting guidance for purchased non-impaired
loans and purchased impaired loans. Refer to Note 1 and
Note 5 of the Notes to Consolidated Financial Statements for
additional information. In addition, refer to the “Analysis and
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