US Bank 2013 Annual Report Download - page 132

Significant Unobservable Inputs of Level 3 Assets and Liabilities
The following section provides information on the significant
inputs used by the Company to determine the fair value
measurements of Level 3 assets and liabilities recorded at
fair value on the Consolidated Balance Sheet. In addition, the
following section includes a discussion of the sensitivity of
the fair value measurements to changes in the significant
inputs and a description of any interrelationships between
these inputs for Level 3 assets and liabilities recorded at fair
value on a recurring basis. The discussion below excludes
nonrecurring fair value measurements of collateral value
used for impairment measures for loans and other real estate
owned. These valuations utilize third party appraisal or
broker price opinions, and are classified as Level 3 due to
the significant judgment involved.
Available-For-Sale Investment Securities The
significant unobservable inputs used in the fair value
measurement of the Company’s modeled Level 3 available-
for-sale investment securities are prepayment rates,
probability of default and loss severities associated with the
underlying collateral, as well as the discount margin used to
calculate the present value of the projected cash flows.
Increases in prepayment rates for Level 3 securities will
typically result in higher fair values, as increased
prepayment rates accelerate the receipt of expected cash
flows and reduce exposure to credit losses. Increases in the
probability of default and loss severities will result in lower
fair values, as these increases reduce expected cash flows.
Discount margin is the Company’s estimate of the current
market spread above the respective benchmark rate. Higher
discount margin will result in lower fair values, as it reduces
the present value of the expected cash flows.
Prepayment rates generally move in the opposite
direction of market interest rates. In the current environment,
an increase in the probability of default will generally be
accompanied with an increase in loss severity, as both are
impacted by underlying collateral values. Discount margins
are influenced by market expectations about the security’s
collateral performance, and therefore may directionally move
with probability and severity of default; however, discount
margins are also impacted by broader market forces, such
as competing investment yields, sector liquidity, economic
news, and other macroeconomic factors.
The following table shows the significant valuation assumption ranges for Level 3 available-for-sale investment securities at
December 31, 2013:
Minimum Maximum Average
Residential Prime Non-Agency Mortgage-Backed Securities (a)
Estimated lifetime prepayment rates ...................................................................... 6% 20% 13%
Lifetime probability of default rates ....................................................................... –74
Lifetime loss severity rates ................................................................................ 25 65 42
Discount margin .......................................................................................... 254
Residential Non-Prime Non-Agency Mortgage-Backed Securities (b)
Estimated lifetime prepayment rates ...................................................................... 2% 10% 6%
Lifetime probability of default rates ....................................................................... 4128
Lifetime loss severity rates ................................................................................ 15 70 54
Discount margin .......................................................................................... 163
Other Asset-Backed Securities
Estimated lifetime prepayment rates ...................................................................... 6% 6% 6%
Lifetime probability of default rates ....................................................................... 555
Lifetime loss severity rates ................................................................................ 40 40 40
Discount margin .......................................................................................... 777
(a) Prime securities are those designated as such by the issuer at origination. When an issuer designation is unavailable, the Company determines at acquisition date the categorization
based on asset pool characteristics (such as weighted-average credit score, loan-to-value, loan type, prevalence of low documentation loans) and deal performance (such as pool
delinquencies and security market spreads).
(b) Includes all securities not meeting the conditions to be designated as prime.
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