American Express 2009 Annual Report Download - page 27

2009 FINANCIAL REVIEW
AMERICAN EXPRESS COMPANY
FAIR VALUE MEASUREMENT
Description Assumptions/Approach Used
Effect if Actual Results Differ
from Assumptions
The Company holds investment securities,
certain subordinated interests in securitized
cardmember loans from the Company’s
securitization program and derivative
instruments. These financial instruments are
reflected at fair value on the Company’s
Consolidated Balance Sheets. Management
makes significant assumptions and judgments
when estimating fair value for these financial
instruments.
Investment Securities
The Company’s investment securities are
comprised of predominantly fixed-income
securities issued by states and municipalities as
well as the U.S. Government and Agencies (e.g.,
Fannie Mae, Freddie Mac or Ginnie Mae) and
retained subordinated securities described
further below. The investment securities are
classified as available-for-sale with changes in
fair value recorded in accumulated other
comprehensive (loss) income within
shareholders’ equity on the Company’s
Consolidated Balance Sheets (except for
approximately $213 million, as of December 31,
2008, of investment securities included in
discontinued operations, for which changes in
fair value are recorded in (loss) income from
discontinued operations in the Company’s
Consolidated Statements of Income).
Securitized Cardmember Loans
When the Company securitizes cardmember
loans, they are accounted for as sales and the
loans are removed from the Company’s
Consolidated Balance Sheets. The Company
retains certain subordinated interests in the
securitized cardmember loans, which may
include one or more investments in tranches of
the securitization (retained subordinated
securities) and an interest-only strip.
In accordance with fair value measurement
and disclosure guidance, the objective of a
fair value measurement is to determine the
price that would be received to sell an asset
or paid to transfer a liability in an orderly
transaction between market participants at
the measurement date (an exit price). The
disclosure guidance establishes a three-level
hierarchy of valuation techniques used to
measure fair value. The fair value hierarchy
gives the highest priority to the
measurement of fair value based on
unadjusted quoted prices in active markets
for identical assets or liabilities (Level 1),
followed by the measurement of fair value
based on pricing models with significant
observable inputs (Level 2), with the lowest
priority given to the measurement of fair
value based on pricing models with
significant unobservable inputs (Level 3).
Investment Securities
The fair market values for the Company’s
investment securities (excluding its retained
subordinated securities, which are discussed
further below) are obtained primarily from
pricing services engaged by the Company.
The fair values provided by the pricing
services are estimated by using pricing
models where the inputs to those models are
based on observable market inputs. The
inputs to the valuation techniques applied
by the pricing services vary depending on
the type of security being priced but are
typically benchmark yields, benchmark
security prices, credit spreads, prepayment
speeds, reported trades and/or broker-dealer
quotes, all with reasonable levels of
transparency. The pricing services do not
apply any adjustments to the pricing models
used. In addition, the Company did not
apply any adjustments to prices received
from the pricing services. The Company has
reaffirmed its understanding of the
valuation techniques used by its pricing
services. In addition, the Company
corroborates the prices provided by its
pricing services to test their reasonableness
by comparing their prices to valuations
(continued on next page)
Investment Securities
In the measurement of fair value for the
Company’s investment securities
(excluding its retained subordinated
securities, which are discussed further
below), even though the underlying
inputs used in the pricing models are
directly observable from active markets
or recent trades of similar securities in
inactive markets, the pricing models do
entail a certain amount of subjectivity
and therefore differing judgments in
how the underlying inputs are modeled
could result in different estimates of fair
value.
Retained Subordinated Securities and
Interest-Only Strip
In measuring the fair value for the
Company’s retained subordinated
securities, the fair value is impacted by
external market factors including
London Interbank Offered Rate
(LIBOR) forward rates and credit
spreads, and therefore, the use of
different inputs to the measurement of
the fair value of the Company’s retained
subordinated securities could result in a
different fair value measurement.
The fair value of the interest-only
strip is impacted by changes in the
estimates and assumptions used in the
valuation models. The use of different
inputs to the measurement of fair value
of these financial instruments could
result in a different fair value
measurement.
Refer to Note 7 to the Company’s
Consolidated Financial Statements,
including sensitivity analyses relating to
changes in key assumptions for the
retained subordinated securities and
interest-only strip.
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