GE 2008 Annual Report Download - page 93

ge 2008 annual report 91
notes to consolidated financial statements
Note 28.
Fair Value Measurements
Effective January 1, 2008, we adopted SFAS 157, Fair Value
Measurements, for all financial instruments and non-financial
instruments accounted for at fair value on a recurring basis.
SFAS 157 establishes a new framework for measuring fair value
and expands related disclosures. Broadly, the SFAS 157 framework
requires fair value to be determined based on the exchange price
that would be received for an asset or paid to transfer a liability
(an exit price) in the principal or most advantageous market for
the asset or liability in an orderly transaction between market
participants. SFAS 157 establishes a three-level valuation hierarchy
based upon observable and non-observable inputs.
For financial assets and liabilities, fair value is the price we
would receive to sell an asset or pay to transfer a liability in an
orderly transaction with a market participant at the measurement
date. In the absence of active markets for the identical assets or
liabilities, such measurements involve developing assumptions
based on market observable data and, in the absence of such
data, internal information that is consistent with what market
participants would use in a hypothetical transaction that occurs
at the measurement date.
Observable inputs reflect market data obtained from indepen-
dent sources, while unobservable inputs reflect our market
assumptions. Preference is given to observable inputs. These two
types of inputs create the following fair value hierarchy:
Level 1 — Quoted prices for identical instruments in active
markets.
Level 2 — Quoted prices for similar instruments in active markets;
quoted prices for identical or similar instruments in
markets that are not active; and model-derived valuations
whose inputs are observable or whose significant value
drivers are observable.
Level 3 — Significant inputs to the valuation model are
unobservable.
We maintain policies and procedures to value instruments using
the best and most relevant data available. In addition, we have
risk management teams that review valuation, including indepen-
dent price validation for certain instruments. Further, in other
instances, we retain independent pricing vendors to assist in
valuing certain instruments.
The following section describes the valuation methodologies
we use to measure different financial instruments at fair value.
Investments in Debt and Equity Securities
When available, we use quoted market prices to determine the fair
value of investment securities, and they are included in Level 1.
Level 1 securities primarily include publicly-traded equity securities.
When quoted market prices are unobservable, we use quotes
from independent pricing vendors based on recent trading activity
and other relevant information including market interest rate
curves, referenced credit spreads and estimated prepayment rates
where applicable. These investments are included in Level 2 and
primarily comprise our portfolio of corporate fixed income, and
government, mortgage and asset-backed securities. In infrequent
circumstances, our pricing vendors may provide us with valuations
that are based on significant unobservable inputs, and in those
circumstances we classify the investment securities in Level 3.
As part of our adoption of SFAS 157 in the first quarter of
2008, we conducted a review of our primary pricing vendor, with
the assistance of an accounting firm, to validate that the inputs
used in that vendor’s pricing process are deemed to be market
observable as defined in the standard. More specifically, we used
a combination of approaches to validate that the process used
by the pricing vendor is consistent with the requirements of the
standard and that the levels assigned to these valuations are
reasonable. While we were not provided access to proprietary
models of the vendor, our review included on-site walk-throughs
of the pricing process, methodologies and control procedures for
each asset class for which prices are provided. Our review also
included an examination of the underlying inputs and assump-
tions for a sample of individual securities, a process we have
continued to perform for each reporting period. Based on this
examination, and the ongoing review performed, we believe that
the valuations used in our financial statements are reasonable
and are appropriately classified in the fair value hierarchy. As of
December 31, 2008, the valuation provided by pricing services
was $26,654 million and was classified in Level 2. The valuations
provided by pricing services based on significant unobservable
inputs was insignificant, and those investment securities are
classified as Level 3.
Retained interests in securitizations are valued using a dis-
counted cash flow model that considers the underlying structure
of the securitization and estimated net credit exposure, prepay-
ment assumptions, discount rates and expected life. Investment
securities priced using non-binding broker quotes and retained
interests are included in Level 3. We use non-binding broker
quotes as our primary basis for valuation when there is limited,
or no, relevant market activity for a specific instrument or for
other instruments that share similar characteristics. We have not
adjusted the prices we have obtained. Level 3 investment securities
valued using non-binding broker quotes totaled $2,074 million
at December 31, 2008, and were classified as available-for-sale
securities. Level 3 retained interests totaled $6,356 million at
December 31, 2008.