American Express 2007 Annual Report Download - page 34

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[ 32 ]
2007 FINANCIAL REVIEW
AMERICAN EXPRESS COMPANY
ASSET SECURITIZATIONS
Description Assumptions/Approach Used Effect if Actual Results Differ
from Assumptions
When the Company securitizes cardmember
loans, it retains certain subordinated interests
in securitized cardmember loans, which may
include one or more investments in tranches
of the securitization (subordinated securities)
and an interest-only strip. Certain estimates
and assumptions are required to determine the
fair value of the Company’s interest-only strip,
and gains recorded at the time of the sale.
The subordinated securities are
accounted for at fair value as Available-for-
Sale investment securities and are reported in
investments on the Company’s Consolidated
Balance Sheets with unrealized gains (losses)
recorded in accumulated other comprehensive
(loss) income.
The interest-only strip is accounted for
at fair value and is reported in other assets on
the Company’s Consolidated Balance Sheets.
Commencing January 1, 2007, the Company
records any changes in the fair value of
the interest-only strip in securitization
income, net in the Consolidated Statements
of Income. Prior to January 1, 2007, the
Company accounted for the changes in the
fair value of the interest-only strip in other
comprehensive (loss) income.
Management estimates fair value of the
subordinated securities using models,
where the inputs to the model are based on
observable market inputs.
Management uses models to determine
the fair value of the interest-only strip and
gain on sale at the time of a cardmember
securitization. The models are based on
projections of finance charges and fees paid
related to the securitized assets, coupon
payments to investors, expected credit losses,
average loan life (i.e., monthly payment rate),
contractual fees to service the securitized
assets, and a discount rate applied to the
cash flows from the interest-only strip that is
commensurate with the inherent risk.
As of December 31, 2007, the total fair value
of subordinated securities and the interest-
only strip was $78 million and $223 million,
respectively.
Fair value of the subordinated securities
is impacted by external market factors
including LIBOR forward rates.
Fair value of the interest-only strip and
gain or loss from the sale of securitization
is impacted by changes in the estimates and
assumptions used in the valuation models.
The three key economic assumptions and
the sensitivity of the current year’s fair value
of the interest-only strip to immediate 10
percent and 20 percent adverse changes in
these assumptions are as follows:
(Millions, except
rates per annum)
Monthly
Payment
Rate
Expected
Credit
Losses
Cash
Flows from
Interest-
only Strips
Discounted
at
Assumption 24.7% 4.3% 12.0%
10% adverse
change $ (14) $ (22) $ (0.4)
20% adverse
change $ (28) $ (43) $ (0.9)
This sensitivity analysis does not
represent management’s expectations of
adverse changes in these assumptions but
is provided as a hypothetical scenario to
assess the sensitivity of the fair value of the
interest-only strip to changes in key inputs.
Management cannot extrapolate changes in
fair value based on a 10 percent or 20 percent
change in all key assumptions simultaneously
in part because the relationship of the change
in one assumption on the fair value of the
retained interest is calculated independent
from any change in another assumption.
Changes in one factor may cause changes in
another, which could magnify or offset the
sensitivities.
32