Navy Federal Credit Union 2014 Annual Report Download - page 65

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Financial Section 47
2014 | A YEAR IN REVIEW
Certain assets and liabilities may be required to be measured at fair value on a non-recurring basis. These
non-recurring fair value measurements usually result from the application of lower of cost or market
accounting or the write-down of individual assets due to impairment.
The following is a description of the valuation methodologies used by Navy Federal for its assets
measured at fair value:
Securities Available-for-Sale (AFS)
Navy Federal receives pricing for AFS securities from a third-party pricing service. These securities are
classified as Level 2 in the fair value hierarchy.
> Residential and Commercial Mortgage-backed Securities—Residential and commercial mortgage-
backed securities include agency and non-agency securities, and are valued either based on similar
assets in the marketplace and the vintage of the underlying collateral, or at the closing price reported
in the active market in which the individual security is traded.
> Federal Agency Securities, Treasury Securities, Municipal Securities and Bank Notes—Federal agency
securities, treasury securities, municipal securities and bank notes are valued based on similar assets
in the marketplace and the vintage of the underlying collateral, or at the closing price reported in the
active market in which the individual security is traded.
Mortgage Servicing Rights (MSRs)
MSRs do not trade in an active, open market with readily observable prices. Navy Federal obtains the fair
value of the MSRs using a third-party pricing provider. The provider uses a combination of market and
income valuation methodologies. All assumptions are market driven. Once the preliminary results are
complete, they are further calibrated to observable market transactions, when they exist. The valuation of
Navy Federal’s MSRs is model driven and primarily based on unobservable inputs and therefore classified
within Level 3 of the fair value hierarchy.
Derivative Assets and Liabilities
Fair values of Navy Federal’s interest rate swaps designated as cash flow and fair value hedges are
determined based on third-party models that calculate the net present value of future cash flows
discounted using the Overnight Indexed Swap (OIS) rate. Counterparty non-performance risk is
considered by discounting future cash flows using OIS rates adjusted for credit quality. Navy Federal
also uses an internal process to further evaluate the risk of counterparty default.
Fair values of Navy Federal’s interest rate lock commitments (IRLCs) are determined based on an
evaluation of best execution forward contract prices sourced from the TBA market, adjusted by a factor
that represents the probability it will settle and become MLAS. IRLCs are classified as Level 2 in the
fair value hierarchy.
Fair values of Navy Federal’s forward sales contracts on TBA securities are determined based on an
evaluation of best execution forward contract prices sourced from the TBA market, by agency. As such,
TBA hedges are classified as Level 2 in the fair value hierarchy.
Mortgage Loans Awaiting Sale (MLAS)
Mortgage loans awaiting sale comprise those loans that Navy Federal intends either to sell or to
securitize. The initial loan level basis is equal to unpaid principal balance plus or minus origination
costs and fees. Navy Federal has elected the fair value option for MLAS. The fair value of MLAS is
determined based on an evaluation of best execution forward sales contract prices sourced from the
TBA market, by agency (e.g., GNMA, FHLMC and FNMA). As such, MLAS are classified as Level 2 in
the fair value hierarchy.