CSE » Topics » Fair Value Measurements

These excerpts taken from the CSE 10-K filed Mar 2, 2009.
Fair Value Measurements
 
Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS No. 157”), which establishes a framework for measuring fair value in generally accepted accounting principles, clarifies the definition of fair value within that framework, and expands disclosures about the use of fair value measurements. This statement applies whenever other accounting standards require or permit fair value measurement. Under this standard, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (the “exit price”) in an orderly transaction between market participants.
 
SFAS No. 157 establishes a fair value hierarchy which prioritizes the inputs into valuation techniques used to measure fair value. The hierarchy prioritizes observable data from active markets, placing measurements using those inputs in Level 1 of the fair value hierarchy, and gives the lowest priority to unobservable inputs and classifies these as Level 3 measurements. The three levels of the fair value hierarchy under SFAS No. 157 are described below:
 
Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date;
 
Level 2 — Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active or models for which all significant inputs are observable in the market either directly or indirectly; and
 
Level 3 — Valuations based on models that use inputs that are unobservable in the market and significant to the overall fair value measurement.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
 
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measurement. Therefore, even when market assumptions are not readily available, management’s own assumptions attempt to reflect those that market participants would use in pricing the asset or liability at the measurement date. For more information on our application of SFAS No. 157, see Note 25, Fair Value Measurements.
 
Fair Value Measurements
 
Effective January 1, 2008, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements (“SFAS No. 157”), which establishes a framework for measuring fair value in generally accepted accounting principles, clarifies the definition of fair value within that framework, and expands disclosures about the use of fair value measurements. This statement applies whenever other accounting standards require or permit fair value measurement. Under this standard, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (the “exit price”) in an orderly transaction between market participants.
 
SFAS No. 157 establishes a fair value hierarchy which prioritizes the inputs into valuation techniques used to measure fair value. The hierarchy prioritizes observable data from active markets, placing measurements using those inputs in Level 1 of the fair value hierarchy, and gives the lowest priority to unobservable inputs and classifies these as Level 3 measurements. The three levels of the fair value hierarchy under SFAS No. 157 are described below:
 
Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that we have the ability to access at the measurement date;
 
Level 2 — Valuations based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active or models for which all significant inputs are observable in the market either directly or indirectly; and
 
Level 3 — Valuations based on models that use inputs that are unobservable in the market and significant to the overall fair value measurement.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
 
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measurement. Therefore, even when market assumptions are not readily available, management’s own assumptions attempt to reflect those that market participants would use in pricing the asset or liability at the measurement date. For more information on our application of SFAS No. 157, see Note 25, Fair Value Measurements.
 
This excerpt taken from the CSE 10-Q filed Nov 10, 2008.
Fair Value Measurements
 
A portion of our assets are accounted for at fair value both on a recurring and nonrecurring basis. Specifically, investments in debt securities that are classified as trading, as well as derivative instruments are periodically adjusted to fair value through earnings. Investments in debt and equity securities that are classified as available-for-sale are adjusted to fair value through accumulated other comprehensive income, while loans held for sale are recorded at the lower of carrying value or fair value. Additionally, the fair value of equity investments is estimated for purposes of assessing and measuring such assets for impairment purposes while we use the fair value of collateral method to assess fair value for certain of our commercial loans for purposes of establishing a specific reserve against those assets.
 
SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants.
 
SFAS No. 157 establishes a fair value hierarchy which prioritizes the inputs into valuation techniques used to measure fair value. The hierarchy prioritizes observable data from active markets, placing measurements using those inputs in Level 1 of the fair value hierarchy, and gives the lowest priority to unobservable inputs and classifies these as Level 3 measurements. The three levels of the fair value hierarchy under SFAS No. 157 are described below:
 
Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement;


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Level 2 — Valuations based on quoted prices for similar assets or in markets that are not active or for which all significant inputs are observable either directly or indirectly;
 
Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
 
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measurement. Therefore, even when market assumptions are not readily available, management’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date.
 
In accordance with SFAS No. 157, it is our policy to maximize the use of observable market based inputs to value our financial instruments carried at fair value on a recurring basis or to determine whether an adjustment to fair value is needed for assets carried at fair value on a non-recurring basis. A number of our financial instruments carried at fair value, whether on a recurring or non-recurring basis, are valued using internal assumptions and, therefore, classified as Level 3 within the SFAS No. 157 hierarchy.
 
The estimations of fair values reflect our best judgments regarding the appropriate valuation methods and assumptions that market participants would use in determining fair value. The selection of a method to estimate fair value for each type of financial instrument depends on the reliability and availability of relevant market data. The amount of judgment involved in estimating the fair value of a financial instrument is affected by a number of factors, such as the type of instrument, the liquidity of the markets for the instrument and the contractual characteristics of the instrument. Judgments in these cases include, but are not limited to:
 
  •  Selection of third-party market data sources;
 
  •  Evaluation of the expected reliability of the estimate;
 
  •  Reliability, timeliness and cost of alternative valuation methodologies; and
 
  •  Selection of proxy instruments, as necessary.
 
For financial instruments that are actively traded in the marketplace or whose values are based on readily available market value data and, therefore, would be classified as either Level 1 or Level 2 within the SFAS No. 157 hierarchy, little, if any, subjectivity is applied when determining the instrument’s fair value. Whether a financial instrument is classified as Level 1 or Level 2 will depend largely on its similarity with other financial instruments in the marketplace and our ability to obtain corroborative data regarding whether the market in which the financial instrument trades is active. Our largest portfolio of financial instruments carried at either Level 1 or Level 2 is our Agency MBS portfolio which is classified as Level 2. For these assets, we obtain information from the pricing services and have validated that there is sufficient due diligence performed by the pricing services to corroborate that the values used to mark the assets to fair value fall within Level 2 of the fair value hierarchy. Other Level 2 assets include equity securities in public companies and our over-the-counter traded derivatives to manage interest rate risk and foreign exchange risk with the values determined using market based yield curves, volatilities, basis spreads and other factors.
 
When observable market prices and data do not exist, significant management judgment is necessary to estimate fair value. In those cases, small changes in assumptions could result in significant changes in valuation. The financial instruments we hold that require the most complex judgments and assumptions involve equity investments that do not have readily determinable fair values and, therefore, are typically classified as Level 3 measurements. Each of these investments is valued using an internally developed model. This model utilizes industry valuation benchmarks, such as multiples of earnings before interest, taxes, depreciation, and amortization (“EBITDA”) ranging from three to ten times, depending on the industry, to determine a value for the underlying enterprise. We reduce this value by debt outstanding to arrive at an estimated equity value of the enterprise. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the pricing indicated by the external event will be used to corroborate our private equity valuation. Because of the inherent uncertainty of


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determining the fair value of investments that do not have a readily ascertainable market value, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.
 
As of September 30, 2008, of the financial assets carried at fair value, $2.4 billion (11.96% of total assets) were classified as Level 1 or 2 while $38.8 million (0.20% of total assets) were classified as Level 3. From a liability perspective, $187.4 million 1.11% of total liabilities) were classified as Level 1 or Level 2 while no liabilities were classified as Level 3.
 
For our Level 3 assets, none of the associated unrealized gains/losses had a significant effect on our results of operations including impacts on liquidity, capital adequacy or other measures. Additionally, we did not experience any material declines in the market values of any of our financial instruments carried at fair value using Level 3 measurements during the three and nine months ended September 30, 2008.
 
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We are exposed to certain financial market risks, which are discussed in detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Market Risk Management section of this Form 10-Q and our Form 10-K. In addition, for a detailed discussion of our derivatives, see Note 22, Derivative Instruments, in our accompanying consolidated financial statements for the three and nine months ended September 30, 2008. and Note 21, Credit Risk, in our audited consolidated financial statements for the year ended December 31, 2007 included in our Form 10-K.
 
ITEM 4.   CONTROLS AND PROCEDURES
 
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2008. There have been no changes in our internal control over financial reporting during the quarter ended September 30, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Fair Value Measurements
 
A portion of our assets are accounted for at fair value both on a recurring and nonrecurring basis. Specifically, investments in debt securities that are classified as trading, as well as derivative instruments are periodically adjusted to fair value through earnings. Investments in debt and equity securities that are classified as available-for-


69


 

sale are adjusted to fair value through accumulated other comprehensive income, while loans held for sale are recorded at the lower of carrying value or fair value. Additionally, the fair value of equity investments is estimated for purposes of assessing and measuring such assets for impairment purposes while we use the fair value of collateral method to assess fair value for certain of our commercial loans for purposes of establishing a specific reserve against those assets.
 
SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants.
 
SFAS No. 157 establishes a fair value hierarchy which prioritizes the inputs into valuation techniques used to measure fair value. The hierarchy prioritizes observable data from active markets, placing measurements using those inputs in Level 1 of the fair value hierarchy, and gives the lowest priority to unobservable inputs and classifies these as Level 3 measurements. The three levels of the fair value hierarchy under SFAS No. 157 are described below:
 
Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement;
 
Level 2 — Valuations based on quoted prices for similar assets or in markets that are not active or for which all significant inputs are observable either directly or indirectly;
 
Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
 
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measurement. Therefore, even when market assumptions are not readily available, management’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date.
 
In accordance with SFAS No. 157, it is our policy to maximize the use of observable market based inputs to value our financial instruments carried at fair value on a recurring basis or to determine whether an adjustment to fair value is needed for assets carried at fair value on a non-recurring basis. A number of our financial instruments carried at fair value, whether on a recurring or non-recurring basis, are valued using internal assumptions and, therefore, classified as Level 3 within the SFAS No. 157 hierarchy.
 
The estimations of fair values reflect our best judgments regarding the appropriate valuation methods and assumptions that market participants would use in determining fair value. The selection of a method to estimate fair value for each type of financial instrument depends on the reliability and availability of relevant market data. The amount of judgment involved in estimating the fair value of a financial instrument is affected by a number of factors, such as the type of instrument, the liquidity of the markets for the instrument and the contractual characteristics of the instrument. Judgments in these cases include, but are not limited to:
 
  •  Selection of third-party market data sources;
 
  •  Evaluation of the expected reliability of the estimate;
 
  •  Reliability, timeliness and cost of alternative valuation methodologies; and
 
  •  Selection of proxy instruments, as necessary.
 
For financial instruments that are actively traded in the marketplace or whose values are based on readily available market value data and, therefore, would be classified as either Level 1 or Level 2 within the SFAS No. 157 hierarchy, little, if any, subjectivity is applied when determining the instrument’s fair value. Whether a financial instrument is classified as Level 1 or Level 2 will depend largely on its similarity with other financial instruments in the marketplace and our ability to obtain corroborative data regarding whether the market in which the financial instrument trades is active. Our largest portfolio of financial instruments carried at either Level 1 or Level 2 is our


70


 

Agency MBS portfolio which is classified as Level 2. For these assets, we obtain information from the pricing services and have validated that there is sufficient due diligence performed by the pricing services to corroborate that the values used to mark the assets to fair value fall within Level 2 of the fair value hierarchy. Other Level 2 assets include equity securities in public companies and our over-the-counter traded derivatives to manage interest rate risk and foreign exchange risk with the values determined using market based yield curves, volatilities, basis spreads and other factors.
 
When observable market prices and data do not exist, significant management judgment is necessary to estimate fair value. In those cases, small changes in assumptions could result in significant changes in valuation. The financial instruments we hold that require the most complex judgments and assumptions involve equity investments that do not have readily determinable fair values and, therefore, are typically classified as Level 3 measurements. Each of these investments is valued using an internally developed model. This model utilizes industry valuation benchmarks, such as multiples of earnings before interest, taxes, depreciation, and amortization (“EBITDA”) ranging from three to ten times, depending on the industry, to determine a value for the underlying enterprise. We reduce this value by debt outstanding to arrive at an estimated equity value of the enterprise. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the pricing indicated by the external event will be used to corroborate our private equity valuation. Because of the inherent uncertainty of determining the fair value of investments that do not have a readily ascertainable market value, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.
 
As of June 30, 2008, of the financial assets carried at fair value, $1.7 billion (11.13% of total assets) were classified as Level 1 or 2 while $163.7 million (1.10% of total assets) were classified as Level 3. From a liability perspective, $180.5 million (1.53% of total liabilities) were classified as Level 1 or Level 2 while no liabilities were classified as Level 3.
 
For our Level 3 assets, none of the associated unrealized gains/losses had a significant effect on our results of operations including impacts on liquidity, capital adequacy or other measures. Additionally, we did not experience any material declines in the market values of any of our financial instruments carried at fair value using Level 3 measurements during the three and six months ended June 30, 2008.
 
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We are exposed to certain financial market risks, which are discussed in detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Market Risk Management section of this Form 10-Q and our Form 10-K. In addition, for a detailed discussion of our derivatives, see Note 17, Derivative Instruments, in our accompanying consolidated financial statements for the three and six months ended June 30, 2008. and Note 21, Credit Risk, in our audited consolidated financial statements for the year ended December 31, 2007 included in our Form 10-K.
 
ITEM 4.   CONTROLS AND PROCEDURES
 
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2008. There have been no changes in our internal control over financial reporting during the quarter ended June 30, 2008, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
Fair Value Measurements
 
A portion of our assets are accounted for at fair value both on a recurring and nonrecurring basis. Specifically, investments in debt securities that are classified as trading, as well as derivative instruments are periodically adjusted to fair value through earnings. Investments in debt and equity securities that are classified as available-for-sale are adjusted to fair value through accumulated other comprehensive income, while loans held for sale are recorded at the lower of carrying value or fair value. Additionally, the fair value of equity investments is estimated for purposes of assessing and measuring such assets for impairment purposes while we use the fair value of collateral method to assess fair value for certain of our commercial loans for purposes of establishing a specific reserve against those assets.
 
SFAS No. 157, Fair Value Measurements (“SFAS No. 157”), defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants.
 
SFAS No. 157 establishes a fair value hierarchy which prioritizes the inputs into valuation techniques used to measure fair value. The hierarchy prioritizes observable data from active markets, placing measurements using those inputs in Level 1 of the fair value hierarchy, and gives the lowest priority to unobservable inputs and classifies these as Level 3 measurements. The three levels of the fair value hierarchy under SFAS No. 157 are described below:
 
Level 1 — Valuations based on unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement;


55


 

Level 2 — Valuations based on quoted prices for similar assets or in markets that are not active or for which all significant inputs are observable either directly or indirectly;
 
Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement.
 
A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
 
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measurement. Therefore, even when market assumptions are not readily available, management’s own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date.
 
In accordance with SFAS No. 157, it is our policy to maximize the use of observable market based inputs to value our financial instruments carried at fair value on a recurring basis or to determine whether an adjustment to fair value is needed for assets carried at fair value on a non-recurring basis. A number of our financial instruments carried at fair value, whether on a recurring or non-recurring basis, are valued using internal assumptions and, therefore, classified as Level 3 within the SFAS No. 157 hierarchy.
 
The estimations of fair values reflect our best judgments regarding the appropriate valuation methods and assumptions that market participants would use in determining fair value. The selection of a method to estimate fair value for each type of financial instrument depends on the reliability and availability of relevant market data. The amount of judgment involved in estimating the fair value of a financial instrument is affected by a number of factors, such as the type of instrument, the liquidity of the markets for the instrument and the contractual characteristics of the instrument. Judgments in these cases include, but are not limited to:
 
  •  Selection of third-party market data sources;
 
  •  Evaluation of the expected reliability of the estimate;
 
  •  Reliability, timeliness and cost of alternative valuation methodologies; and
 
  •  Selection of proxy instruments, as necessary.
 
For financial instruments that are actively traded in the marketplace or whose values are based on readily available market value data and, therefore, would be classified as either Level 1 or Level 2 within the SFAS No. 157 hierarchy, little, if any, subjectivity is applied when determining the instrument’s fair value. Whether a financial instrument is classified as Level 1 or Level 2 will depend largely on its similarity with other financial instruments in the marketplace and our ability to obtain corroborative data regarding whether the market in which the financial instrument trades is active. Our largest portfolio of financial instruments carried at either Level 1 or Level 2 is our Agency MBS portfolio which is classified as Level 2. For these assets, we obtain information from the pricing services and have validated that there is sufficient due diligence performed by the pricing services to corroborate that the values used to mark the assets to fair value fall within Level 2 of the fair value hierarchy. Other Level 2 assets include equity securities in public companies and our over-the-counter traded derivatives to manage interest rate risk and foreign exchange risk with the values determined using market based yield curves, volatilities, basis spreads and other factors.
 
When observable market prices and data do not exist, significant management judgment is necessary to estimate fair value. In those cases, small changes in assumptions could result in significant changes in valuation. The financial instruments we hold that require the most complex judgments and assumptions involve equity investments that do not have readily determinable fair values and, therefore, are typically classified as Level 3 measurements. Each of these investments is valued using an internally developed model. This model utilizes industry valuation benchmarks, such as multiples of earnings before interest, taxes, depreciation, and amortization (“EBITDA”) ranging from three to ten times, depending on the industry, to determine a value for the underlying enterprise. We reduce this value by debt outstanding to arrive at an estimated equity value of the enterprise. When an external event such as a purchase transaction, public offering or subsequent equity sale occurs, the pricing indicated by the external event will be used to corroborate our private equity valuation. Because of the inherent uncertainty of


56


 

determining the fair value of investments that do not have a readily ascertainable market value, the fair value of our investments may differ significantly from the values that would have been used had a ready market existed for the investments, and the differences could be material.
 
As of March 31, 2008, of the financial assets carried at fair value, $3.5 billion (19% of total assets) were classified as Level 1 or 2 while $163.9 million (0.9% of total assets) were classified as Level 3. From a liability perspective, $325.4 million (2% of total liabilities) were classified as Level 1 or Level 2 while $13.3 million (0.1% of total liabilities) were classified as Level 3.
 
For our Level 3 assets, none of the associated unrealized gains/losses had a significant affect on our results of operations including impacts on liquidity, capital adequacy or other measures. Additionally, we did not experience any material declines in the market values of any of our financial instruments carried at fair value using Level 3 measurements during the three months ended March 31, 2008.
 
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We are exposed to certain financial market risks, which are discussed in detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Market Risk Management section of this Form 10-Q and our Form 10-K. In addition, for a detailed discussion of our derivatives, see Note 17, Derivative Instruments, in our accompanying consolidated financial statements for the three months ended March 31, 2008. and Note 21, Credit Risk, in our audited consolidated financial statements for the year ended December 31, 2007 included in our Form 10-K.
 
ITEM 4.   CONTROLS AND PROCEDURES
 
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2008.
 
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