American Express 2009 Annual Report Download - page 81

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
AMERICAN EXPRESS COMPANY
Interest-only Strip
The fair value of the interest-only strip is the present value of
estimated future positive excess spread expected to be
generated by the securitized loans over the estimated
remaining life of those loans. Management utilizes certain
estimates and assumptions to determine the fair value of the
interest-only strip asset, including estimates for finance
charge yield, credit losses, London Interbank Offered Rate
(LIBOR) (which determines future certificate interest costs),
monthly payment rate and discount rate. On a quarterly basis,
the Company compares the assumptions it uses in calculating
the fair value of its interest-only strip to observable market
data when available, and to historical trends. The interest-
only strip is classified within Level 3 of the fair value hierarchy
due to the significance of the unobservable inputs used in
valuing this asset. Refer to Note 7 for additional fair value
information.
Derivative Financial Instruments
The fair value of the Company’s derivative financial
instruments, which could be assets or liabilities on the
Consolidated Balance Sheets, is estimated by using either a
third-party valuation service that uses proprietary pricing
models, or by using internal pricing models, neither of which
contain a high level of subjectivity as the valuation techniques
used do not require significant judgment and inputs to those
models are readily observable from actively quoted markets.
In each case, the valuation models used are consistently
applied and reflect the contractual terms of the derivatives,
including the period of maturity, and market-based
parameters such as interest rates, foreign exchange rates,
equity indices or prices, and volatility.
Credit valuation adjustments are necessary when the
market parameters (for example, a benchmark curve) used to
value derivatives are not indicative of the credit quality of the
Company or its counterparties. The Company considers the
counterparty credit risk by applying an observable forecasted
default rate to the current exposure. Refer to Note 12 for
additional fair value information.
The following table discloses the estimated fair values for the
Company’s financial assets and financial liabilities not carried
at fair value as of December 31:
(Rounded to nearest billion) 2009 2008
Carrying
Value
Fair
Value
Carrying
Value
Fair
Value
Financial Assets:
Assets for which carrying
values equal or
approximate fair value $57 $57 $58 $58
Loans $30 $30 $41 $41
Financial Liabilities:
Liabilities for which
carrying values equal
or approximate fair
value $33 $33 $37 $37
Certificates of deposit $15 $16 $8 $7
Long-term debt $52 $54 $60 $56
The fair values of these financial instruments are estimates
based upon market conditions and perceived risks as of
December 31, 2009 and 2008, and require management
judgment. These figures may not be indicative of their future
fair values. The fair value of the Company cannot be
estimated by aggregating the amounts presented.
The following methods were used to determine estimated
fair values:
FINANCIAL ASSETS FOR WHICH CARRYING VALUES
EQUAL OR APPROXIMATE FAIR VALUE
Financial assets for which carrying values equal or
approximate fair value include cash and cash equivalents,
cardmember receivables, accrued interest and certain other
assets. For these assets, the carrying values approximate fair
value because they are short-term in duration or variable rate
in nature.
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