Bank of America 2011 Annual Report Download - page 161

Bank of America 2011 159
Mortgage Servicing Rights
The Corporation accounts for consumer-related MSRs at fair value
with changes in fair value recorded in mortgage banking income,
while commercial-related and residential reverse mortgage MSRs
are accounted for using the amortization method (lower of
amortized cost or fair value) with impairment recognized as a
reduction in mortgage banking income. To reduce the volatility of
earnings related to interest rate and market value fluctuations,
U.S. Treasury securities, mortgage-backed securities (MBS) and
derivatives such as options and interest rate swaps may be used
as economic hedges of the MSRs, but are not designated as
accounting hedges. These economic hedges are carried at fair
value with changes in fair value recognized in mortgage banking
income.
The Corporation estimates the fair value of the consumer MSRs
using a valuation model that calculates the present value of
estimated future net servicing income. This is accomplished
through an option-adjusted spread (OAS) valuation approach that
factors in prepayment risk. This approach consists of projecting
servicing cash flows under multiple interest rate scenarios and
discounting these cash flows using risk-adjusted discount rates.
The key economic assumptions used in valuations of MSRs include
weighted-average lives of the MSRs and the OAS levels. The OAS
represents the spread that is added to the discount rate so that
the sum of the discounted cash flows equals the market price,
therefore it is a measure of the extra yield over the reference
discount factor that the Corporation expects to earn by holding the
asset. These variables can, and generally do, change from quarter
to quarter as market conditions and projected interest rates
change, and could have an adverse impact on the value of the
MSRs and could result in a corresponding reduction in mortgage
banking income.
Goodwill and Intangible Assets
Goodwill is the purchase premium after adjusting for the fair value
of net assets acquired. Goodwill is not amortized but is reviewed
for potential impairment on an annual basis, or when events or
circumstances indicate a potential impairment, at the reporting
unit level. A reporting unit, as defined under applicable accounting
guidance, is a business segment or one level below a business
segment. The goodwill impairment analysis is a two-step test.
During 2011, the Corporation early adopted new accounting
guidance that simplifies goodwill impairment testing by permitting
entities to make a qualitative assessment of whether it is likely
that the fair value of a reporting unit is less than its carrying value.
For additional information, see New Accounting Pronouncements
in this Note on page 152. The first step of the goodwill impairment
test involves comparing the fair value of each reporting unit with
its carrying amount including goodwill. If the fair value of the
reporting unit exceeds its carrying amount, goodwill of the reporting
unit is considered not impaired; however, if the carrying amount
of the reporting unit exceeds its fair value, the second step must
be performed to measure potential impairment.
The second step involves calculating an implied fair value of
goodwill for each reporting unit for which the first step indicated
possible impairment. The implied fair value of goodwill is
determined in the same manner as the amount of goodwill
recognized in a business combination, which is the excess of the
fair value of the reporting unit, as determined in the first step, over
the aggregate fair values of the assets, liabilities and identifiable
intangibles as if the reporting unit was being acquired in a business
combination. Measurement of the fair values of the assets and
liabilities of a reporting unit is consistent with the requirements
of the fair value measurements accounting guidance, which
defines fair value as an exit price, meaning 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. The adjustments to measure the assets,
liabilities and intangibles at fair value are for the purpose of
measuring the implied fair value of goodwill and such adjustments
are not reflected in the Consolidated Balance Sheet. If the implied
fair value of goodwill exceeds the goodwill assigned to the reporting
unit, there is no impairment. If the goodwill assigned to a reporting
unit exceeds the implied fair value of goodwill, an impairment
charge is recorded for the excess. An impairment loss recognized
cannot exceed the amount of goodwill assigned to a reporting unit.
An impairment loss establishes a new basis in the goodwill and
subsequent reversals of goodwill impairment losses are not
permitted under applicable accounting guidance.
For intangible assets subject to amortization, an impairment
loss is recognized if the carrying amount of the intangible asset
is not recoverable and exceeds fair value. The carrying amount of
the intangible asset is considered not recoverable if it exceeds
the sum of the undiscounted cash flows expected to result from
the use of the asset.
Variable Interest Entities
A VIE is an entity that lacks equity investors or whose equity
investors do not have a controlling financial interest in the entity
through their equity investments. The entity that has a controlling
financial interest in a VIE is referred to as the primary beneficiary
and consolidates the VIE. The Corporation is deemed to have a
controlling financial interest and is the primary beneficiary of a VIE
if it has both the power to direct the activities of the VIE that most
significantly impact the VIE’s economic performance and an
obligation to absorb losses or the right to receive benefits that
could potentially be significant to the VIE. On a quarterly basis,
the Corporation reassesses whether it has a controlling financial
interest in and is the primary beneficiary of a VIE. The quarterly
reassessment process considers whether the Corporation has
acquired or divested the power to direct the activities of the VIE
through changes in governing documents or other circumstances.
The reassessment also considers whether the Corporation has
acquired or disposed of a financial interest that could be significant
to the VIE, or whether an interest in the VIE has become significant
or is no longer significant. The consolidation status of the VIEs
with which the Corporation is involved may change as a result of
such reassessments. Changes in consolidation status are applied
prospectively, with assets and liabilities of a newly consolidated
VIE initially recorded at fair value. A gain or loss may be recognized
upon deconsolidation of a VIE depending on the carrying amounts
of deconsolidated assets and liabilities compared to the fair value
of retained interests and ongoing contractual arrangements.
The Corporation primarily uses VIEs for its securitization
activities, in which the Corporation transfers whole loans or debt
securities into a trust or other vehicle such that the assets are
legally isolated from the creditors of the Corporation. Assets held
in a trust can only be used to settle obligations of the trust. The
creditors of these trusts typically have no recourse to the
Corporation except in accordance with the Corporation’s
obligations under standard representations and warranties.