Wells Fargo 2013 Annual Report Download - page 219

can be subject to fair value measurements on a nonrecurring
basis. Changes in the fair value of MSRs occur primarily due to
the collection/realization of expected cash flows, as well as
changes in valuation inputs and assumptions. For other interests
held in securitizations (such as interest-only strips), we use a
valuation model that calculates the present value of estimated
future cash flows. The model incorporates our own estimates of
assumptions market participants use in determining the fair
value, including estimates of prepayment speeds, discount rates,
defaults and contractual fee income. Interest-only strips are
recorded as trading assets. Our valuation approach is validated
by our internal valuation model validation group. Fair value
measurements of our MSRs and interest-only strips use
significant unobservable inputs and, accordingly, we classify
them as Level 3.
FORECLOSED ASSETS Foreclosed assets are carried at net
realizable value, which represents fair value less costs to sell.
Fair value is generally based upon independent market prices or
appraised values of the collateral and, accordingly, we classify
foreclosed assets as Level 2.
NONMARKETABLE EQUITY INVESTMENTS We have elected
the fair value option for certain nonmarketable equity
investments. The remaining nonmarketable equity investments
are generally recorded under the cost or equity method of
accounting. There are generally restrictions on the sale and/or
liquidation of these investments, including federal bank stock.
Federal bank stock carrying value approximates fair value. We
use facts and circumstances available to estimate the fair value of
our nonmarketable equity investments. We typically consider
our access to and need for capital (including recent or projected
financing activity), qualitative assessments of the viability of the
investee, evaluation of the financial statements of the investee
and prospects for its future. Public equity investments are valued
using quoted market prices and discounts are only applied when
there are trading restrictions that are an attribute of the
investment. We estimate the fair value of investments in non-
public securities using metrics such as security prices of
comparable public companies, acquisition prices for similar
companies and original investment purchase price multiples,
while also incorporating a portfolio company's financial
performance and specific factors. For investments in private
equity funds, we use the NAV provided by the fund sponsor as an
appropriate measure of fair value. In some cases, such NAVs
require adjustments based on certain unobservable inputs.
Liabilities
DEPOSIT LIABILITIES Deposit liabilities are carried at
historical cost. The fair value of deposits with no stated maturity,
such as noninterest-bearing demand deposits, interest-bearing
checking, and market rate and other savings, is equal to the
amount payable on demand at the measurement date. The fair
value of other time deposits is calculated based on the
discounted value of contractual cash flows. The discount rate is
estimated using the rates currently offered for like wholesale
deposits with similar remaining maturities.
SHORT-TERM FINANCIAL LIABILITIES Short-term financial
liabilities are carried at historical cost and include federal funds
purchased and securities sold under repurchase agreements,
commercial paper and other short-term borrowings. The
carrying amount is a reasonable estimate of fair value because of
the relatively short time between the origination of the
instrument and its expected realization.
OTHER LIABILITIES Other liabilities recorded at fair value on
a recurring basis, excluding derivative liabilities (see the
“Derivatives” section for derivative liabilities), includes primarily
short sale liabilities. Short sale liabilities are predominantly
classified as either Level 1 or Level 2, generally dependent upon
whether the underlying securities have readily obtainable quoted
prices in active exchange markets.
LONG-TERM DEBT Long-term debt is generally carried at
amortized cost. For disclosure, we are required to estimate the
fair value of long-term debt. Generally, the discounted cash flow
method is used to estimate the fair value of our long-term debt.
Contractual cash flows are discounted using rates currently
offered for new notes with similar remaining maturities and, as
such, these discount rates include our current spread levels.
Level 3 Asset and Liability Valuation Processes
We generally determine fair value of our Level 3 assets and
liabilities by using internally developed models and, to a lesser
extent, prices obtained from third-party pricing services or
brokers (collectively, vendors). Our valuation processes vary
depending on which approach is utilized.
INTERNAL MODEL VALUATIONS Our internally developed
models primarily consist of discounted cash flow techniques. Use
of such techniques requires determining relevant inputs, some of
which are unobservable. Unobservable inputs are generally
derived from historic performance of similar assets or
determined from previous market trades in similar instruments.
These unobservable inputs usually consist of discount rates,
default rates, loss severity upon default, volatilities, correlations
and prepayment rates, which are inherent within our Level 3
instruments. Such inputs can be correlated to similar portfolios
with known historic experience or recent trades where particular
unobservable inputs may be implied; but due to the nature of
various inputs being reflected within a particular trade, the value
of each input is considered unobservable. We attempt to
correlate each unobservable input to historic experience and
other third party data where available.
Internal valuation models are subject to review prescribed
within our model risk management policies and procedures,
which include model validation. The purpose of model validation
includes ensuring the model is appropriate for its intended use
and the appropriate controls exist to help mitigate risk of invalid
valuations. Model validation assesses the adequacy and
appropriateness of the model, including reviewing its key
components, such as inputs, processing components, logic or
theory, output results and supporting model documentation.
Validation also includes ensuring significant unobservable
model inputs are appropriate given observable market
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