Bank of America 2015 Annual Report Download - page 238

236 Bank of America 2015
In the tables above, instruments backed by residential and
commercial real estate assets include RMBS, commercial
mortgage-backed securities, whole loans and mortgage CDOs.
Commercial loans, debt securities and other include corporate
CLOs and CDOs, commercial loans and bonds, and securities
backed by non-real estate assets. Structured liabilities primarily
include equity-linked notes that are accounted for under the fair
value option.
The Corporation uses multiple market approaches in valuing
certain of its Level 3 financial instruments. For example, market
comparables and discounted cash flows are used together. For a
given product, such as corporate debt securities, market
comparables may be used to estimate some of the unobservable
inputs and then these inputs are incorporated into a discounted
cash flow model. Therefore, the balances disclosed encompass
both of these techniques.
The level of aggregation and diversity within the products
disclosed in the tables result in certain ranges of inputs being
wide and unevenly distributed across asset and liability categories.
For more information on the inputs and techniques used in the
valuation of MSRs, see Note 23 – Mortgage Servicing Rights.
Sensitivity of Fair Value Measurements to Changes in
Unobservable Inputs
Loans and Securities
For instruments backed by residential real estate assets,
commercial real estate assets and commercial loans, debt
securities and other, a significant increase in market yields, default
rates, loss severities or duration would result in a significantly
lower fair value for long positions. Short positions would be
impacted in a directionally opposite way. The impact of changes
in prepayment speeds would have differing impacts depending on
the seniority of the instrument and, in the case of CLOs, whether
prepayments can be reinvested.
For auction rate securities, a significant increase in price would
result in a significantly higher fair value.
Structured Liabilities and Derivatives
For credit derivatives, a significant increase in market yield,
including spreads to indices, upfront points (i.e., a single upfront
payment made by a protection buyer at inception), credit spreads,
default rates or loss severities would result in a significantly lower
fair value for protection sellers and higher fair value for protection
buyers. The impact of changes in prepayment speeds would have
differing impacts depending on the seniority of the instrument and,
in the case of CLOs, whether prepayments can be reinvested.
Structured credit derivatives, which include tranched portfolio
CDS and derivatives with derivative product company (DPC) and
monoline counterparties, are impacted by credit correlation,
including default and wrong-way correlation. Default correlation is
a parameter that describes the degree of dependence among
credit default rates within a credit portfolio that underlies a credit
derivative instrument. The sensitivity of this input on the fair value
varies depending on the level of subordination of the tranche. For
senior tranches that are net purchases of protection, a significant
increase in default correlation would result in a significantly higher
fair value. Net short protection positions would be impacted in a
directionally opposite way. Wrong-way correlation is a parameter
that describes the probability that as exposure to a counterparty
increases, the credit quality of the counterparty decreases. A
significantly higher degree of wrong-way correlation between a DPC
counterparty and underlying derivative exposure would result in a
significantly lower fair value.
For equity derivatives, commodity derivatives, interest rate
derivatives and structured liabilities, a significant change in long-
dated rates and volatilities and correlation inputs (e.g., the degree
of correlation between an equity security and an index, between
two different commodities, between two different interest rates,
or between interest rates and foreign exchange rates) would result
in a significant impact to the fair value; however, the magnitude
and direction of the impact depends on whether the Corporation
is long or short the exposure.