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Consolidated Investment Entities
 9 Months Ended
Sep. 30, 2013
Consolidated Investment Entities  
Consolidated Investment Entities
Consolidated Investment Entities
 
The Company provides asset management services to various collateralized debt obligations (“CDOs”) and other investment products (collectively, “investment entities”), which are sponsored by the Company. Certain of these investment entities are considered to be VIEs while others are considered to be voting rights entities (“VREs”). The Company consolidates certain of these investment entities.
 
The CDOs managed by the Company are considered VIEs. These CDOs are asset backed financing entities collateralized by a pool of assets, primarily syndicated loans and, to a lesser extent, high-yield bonds. Multiple tranches of debt securities are issued by a CDO, offering investors various maturity and credit risk characteristics. The debt securities issued by the CDOs are non-recourse to the Company. The CDO’s debt holders have recourse only to the assets of the CDO. The assets of the CDOs cannot be used by the Company. Scheduled debt payments are based on the performance of the CDO’s collateral pool. The Company generally earns management fees from the CDOs based on the par value of outstanding debt and, in certain instances, may also receive performance-based fees. In the normal course of business, the Company has invested in certain CDOs, generally an insignificant portion of the unrated, junior subordinated debt.
 
For certain of the CDOs, the Company has determined that consolidation is required as it has power over the CDOs and holds a variable interest in the CDOs for which the Company has the potential to receive benefits or the potential obligation to absorb losses that are significant to the CDO. For other CDOs managed by the Company, the Company has determined that consolidation is not required as the Company does not hold a variable interest in the CDOs or it does hold a variable interest but does not have the potential to receive benefits or the potential obligation to absorb losses that are significant to the CDO.
 
The Company provides investment advice and related services to private, pooled investment vehicles organized as limited partnerships, limited liability companies or foreign (non-U.S.) entities. Certain of these pooled investment vehicles are considered VIEs while others are VREs. For investment management services, the Company generally earns management fees based on the market value of assets under management, and in certain instances may also receive performance-based fees. The Company provides seed money occasionally to certain of these funds. For certain of the pooled investment vehicles, the Company has determined that consolidation is required as the Company stands to absorb a majority of the entity’s expected losses or receive a majority of the entity’s expected residual returns. For other VIE pooled investment vehicles, the Company has determined that consolidation is not required because the Company is not expected to absorb the majority of the expected losses or receive the majority of the expected residual returns. For the pooled investment vehicles which are VREs, the Company consolidates the structure when it has a controlling financial interest.
 
The Company also provides investment advisory, distribution and other services to the Columbia and Threadneedle mutual fund families. The Company has determined that consolidation is not required for these mutual funds.
 
In addition, the Company may invest in structured investments including VIEs for which it is not the sponsor. These structured investments typically invest in fixed income instruments and are managed by third parties and include asset backed securities, commercial mortgage backed securities and residential mortgage backed securities. The Company includes these investments in Available-for-Sale securities. The Company has determined that it is not the primary beneficiary of these structures due to its relative size, position in the capital structure of these entities and the Company’s lack of power over the structures. The Company’s maximum exposure to loss as a result of its investment in structured investments that it does not consolidate is limited to its carrying value. The Company has no obligation to provide further financial or other support to these structured investments nor has the Company provided any support to these structured investments. See Note 4 for additional information about these structured investments.

Fair Value of Assets and Liabilities
 
The Company categorizes its fair value measurements according to a three-level hierarchy. See Note 10 for the definition of the three levels of the fair value hierarchy.
 
The following tables present the balances of assets and liabilities held by consolidated investment entities measured at fair value on a recurring basis:
 
September 30, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Assets
 

 
 

 
 

 
 

Investments:
 

 
 

 
 

 
 

Corporate debt securities
$
—

 
$
217

 
$
2

 
$
219

U.S. government and agencies obligations
3

 
—

 
—

 
3

Common stocks
136

 
32

 
7

 
175

Other structured investments
—

 
33

 
—

 
33

Syndicated loans
—

 
3,904

 
302

 
4,206

Total investments
139

 
4,186

 
311

 
4,636

Receivables
—

 
26

 
—

 
26

Other assets
—

 
9

 
1,591

 
1,600

Total assets at fair value
$
139

 
$
4,221

 
$
1,902

 
$
6,262

Liabilities
 

 
 

 
 

 
 

Debt
$
—

 
$
—

 
$
4,459

 
$
4,459

Other liabilities
—

 
94

 
—

 
94

Total liabilities at fair value
$
—

 
$
94

 
$
4,459

 
$
4,553

 
 
December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in millions)
Assets
 

 
 

 
 

 
 

Investments:
 

 
 

 
 

 
 

Corporate debt securities
$
—

 
$
251

 
$
3

 
$
254

Common stocks
91

 
32

 
14

 
137

Other structured investments
—

 
57

 
—

 
57

Syndicated loans
—

 
3,720

 
202

 
3,922

Total investments
91

 
4,060

 
219

 
4,370

Receivables
—

 
77

 
—

 
77

Other assets
—

 
2

 
1,214

 
1,216

Total assets at fair value
$
91

 
$
4,139

 
$
1,433

 
$
5,663

Liabilities
 

 
 

 
 

 
 

Debt
$
—

 
$
—

 
$
4,450

 
$
4,450

Other liabilities
—

 
166

 
—

 
166

Total liabilities at fair value
$
—

 
$
166

 
$
4,450

 
$
4,616


 
The following tables provide a summary of changes in Level 3 assets and liabilities held by consolidated investment entities measured at fair value on a recurring basis:
 
Corporate
Debt
Securities
 
Common
Stocks
 
Syndicated
Loans
 
Other
Assets
 
Debt
 
 
(in millions)
  
#VALUE!
$
3

 
$
16

  
$
292

  
$
1,322

  
$
(4,677
)
 
Total gains (losses) included in:
 

 
 

  
 

  
 

  
 

  
Net income
—

 
(1
)
(1) 
(1
)
(1) 
20

(2) 
50

(1) 
Other comprehensive income
—

 
—

  
—

  
73

  
—

  
Purchases
—

 
—

  
72

  
239

  
—

  
Sales
—

 
—

 
(8
)
 
(54
)
 
—

 
Issues
—

 
—

 
—

 
—

  
—

 
Settlements
(1
)
 
—

 
(13
)
 
—

  
168

 
Transfers into Level 3
—

 
—

 
105

 
—

  
—

 
Transfers out of Level 3
—

 
(8
)
 
(145
)
 
(9
)
  
—

 
Balance, September 30, 2013
$
2

 
$
7

 
$
302

  
$
1,591

  
$
(4,459
)
 
Changes in unrealized gains (losses) included in income relating to assets and liabilities held at September 30, 2013
$
—

 
$
(1
)
(1) 
$
(2
)
(1) 
$
(1
)
(2) 
$
50

(1) 
(1) Included in net investment income in the Consolidated Statements of Operations.
(2) Included in other revenues in the Consolidated Statements of Operations.
 
 
Corporate
Debt
Securities
 
Common
Stocks
 
Syndicated
Loans
 
Other
Assets
 
Debt
 
 
(in millions)
  
#VALUE!
$
4

 
$
12

 
$
169

  
$
1,080

  
$
(4,726
)
 
Total gains (losses) included in:
 

 
 

 
 

  
 

  
 

  
Net income
—

 
—


2

(1) 
(27
)
(2) 
(82
)
(1) 
Other comprehensive income
—

 
—

 
—

  
21

 
—

  
Purchases
—

 
—

 
26

 
146

 
—

  
Sales
—

 
—

 
(2
)
 
(62
)
 
—

  
Settlements
—

 
—

 
(22
)
 
—

 
117

  
Transfers into Level 3
—

 
1

 
59

 
—

  
—

  
Transfers out of Level 3
—

 
—

 
(49
)
 
—

  
—

  
Balance, September 30, 2012
$
4

 
$
13

 
$
183

 
$
1,158

  
$
(4,691
)
 
Changes in unrealized gains (losses) included in income relating to assets and liabilities held at September 30, 2012
$
—

 
$
—

 
$
1

(1) 
$
(39
)
(2) 
$
(81
)
(1) 
(1) Included in net investment income in the Consolidated Statements of Operations.
(2) Included in other revenues in the Consolidated Statements of Operations.

 
Corporate
Debt
Securities
 
Common
Stocks
 
Syndicated
Loans
 
Other
Assets
 
Debt
 
 
(in millions)
  
Balance, January 1, 2013
$
3

 
$
14

  
$
202

  
$
1,214

  
$
(4,450
)
 
Total gains (losses) included in:
 

 
 

  
 

  
 

  
 

  
Net income
—

 
—


—


22

(2) 
(38
)
(1) 
Other comprehensive income (loss)
—

 
—

  
—

  
(1
)
 
—

  
Purchases
1

 
—

 
265

 
434

 
—

  
Sales
(1
)
 
(3
)
 
(52
)
 
(77
)
 
—

  
Issues
—

 
—

 
—

 
—

  
(926
)
 
Settlements
(1
)
 
—

 
(46
)
 
—

  
955

 
Transfers into Level 3
—

 
15

 
232

 
8

  
—

 
Transfers out of Level 3
—

 
(19
)
 
(299
)
 
(9
)
  
—

 
Balance, September 30, 2013
$
2

 
$
7

  
$
302

  
$
1,591

  
$
(4,459
)
 
Changes in unrealized gains (losses) included in income relating to assets and liabilities held at September 30, 2013
—

 
(2
)
(1) 
(1
)
(1) 
5

(2) 
(10
)
(1) 
 
(1) Included in net investment income in the Consolidated Statements of Operations.
(2) Included in other revenues in the Consolidated Statements of Operations.
 
 
Corporate
Debt
Securities
 
Common
Stocks
 
Syndicated
Loans
 
Other
Assets
 
Debt
 
 
(in millions)
  
Balance, January 1, 2012
$
4

 
$
13

  
$
342

  
$
1,108

  
$
(4,712
)
 
Total gains (losses) included in:
 

 
 

  
 

  
 

  
 

  
Net income
—

 
(1
)
(1) 
6

(1) 
(64
)
(2) 
(223
)
(1) 
Other comprehensive income
—

 
—

  
—

  
20

  
—

  
Purchases
—

 
6

  
59

  
254

  
—

  
Sales
—

 
(4
)
 
(8
)
 
(160
)
 
—

  
Issues
—

 
—

  
—

 
—

  
—

  
Settlements
—

 
—

  
(84
)
 
—

  
244

  
Transfers into Level 3
—

 
14

  
186

 
—

  
—

  
Transfers out of Level 3
—

 
(15
)
 
(318
)
 
—

  
—

  
Balance, September 30, 2012
$
4

 
$
13

  
$
183

  
$
1,158

  
$
(4,691
)
 
Changes in unrealized losses included in income relating to assets and liabilities held at September 30, 2012
$
—

 
$
—

  
$
—


$
(86
)
(2) 
$
(221
)
(1) 
(1) Included in net investment income in the Consolidated Statements of Operations.
(2) Included in other revenues in the Consolidated Statements of Operations.
 
Securities and loans transferred from Level 2 to Level 3 represent assets with fair values that are now based on a single non-binding broker quote. Securities and loans transferred from Level 3 to Level 2 represent assets with fair values that are now obtained from a third party pricing service with observable inputs or priced in active markets. During the reporting periods, there were no transfers between Level 1 and Level 2.
 
The following tables provide a summary of the significant unobservable inputs used in the fair value measurements developed by the Company or reasonably available to the Company of Level 3 assets and liabilities held by consolidated investment entities:
 
September 30, 2013
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range 
 
Weighted Average
 
(in millions)
 
 
 
 
 
 
 
 
 
Other assets
$
1,591

 
Discounted cash flow/ market comparables
 
Equivalent yield
 
3.5
%
–
12.5%
 
7.6
%
 
 

 
 
 
Expected rental value (per square foot)
 
$5
–
$308
 
$29
 
 
 
 
 
 
 
 
 
 
 
 
Debt
$
4,459

 
Discounted cash flow
 
Annual default rate
 
2.5
%
–
2.5%
 
2.5
%
 
 

 
 
 
Discount rate
 
1.5
%
–
9.3%
 
2.8
%
 
 

 
 
 
Constant prepayment rate
 
5.0
%
–
10.0%
 
9.7
%
 
 

 
 
 
Loss recovery
 
36.4
%
–
63.6%
 
62.5
%
 
December 31, 2012
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Range 
 
Weighted Average
 
(in millions)
 
 
 
 
 
 
 
 
 
Other assets
$
1,214

 
Discounted cash flow/ market comparables
 
Equivalent yield
 
4.1
%
–
12.9%
 
7.2
%
 
 

 
 
 
Expected rental value (per square foot)
 
$4
–
$309
 
$32
 
 
 
 
 
 
 
 
 
 
 
 
Debt
$
4,450

 
Discounted cash flow
 
Annual default rate
 
2.5
%
–
4.5%
 
2.5
%
 
 

 
 
 
Discount rate
 
1.6
%
–
30.0%
 
2.9
%
 
 

 
 
 
Constant prepayment rate
 
5.0
%
–
10.0%
 
9.6
%
 
 

 
 
 
Loss recovery
 
36.4
%
–
63.6%
 
62.0
%
 
Level 3 measurements not included in the tables above are obtained from non-binding broker quotes where unobservable inputs are not reasonably available to the Company.
 
Sensitivity of Fair Value Measurements to Changes in Unobservable Inputs
 
Generally, a significant increase (decrease) in the expected rental value used in the fair value measurement of properties held by consolidated investment entities in isolation would result in a significantly higher (lower) fair value measurement and a significant increase (decrease) in the equivalent yield in isolation would result in a significantly lower (higher) fair value measurement.
 
Generally, a significant increase (decrease) in the annual default rate and discount rate used in the fair value measurement of the CDO’s debt in isolation would result in a significantly lower (higher) fair value measurement and a significant increase (decrease) in loss recovery in isolation would result in a significantly higher (lower) fair value measurement. A significant increase (decrease) in the constant prepayment rate in isolation would result in a significantly higher (lower) fair value measurement.
 
Determination of Fair Value
 
Assets
 
Investments
 
The fair value of syndicated loans obtained from third party pricing services with multiple non-binding broker quotes as the underlying valuation source is classified as Level 2. The fair value of syndicated loans obtained from third party pricing services with a single non-binding broker quote as the underlying valuation source is classified as Level 3. The underlying inputs used in non-binding broker quotes are not readily available to the Company.
 
In consideration of the above, management is responsible for the fair values recorded on the financial statements. Prices received from third party pricing services are subjected to exception reporting that identifies loans with significant daily price movements as well as no movements. The Company reviews the exception reporting and resolves the exceptions through reaffirmation of the price or recording an appropriate fair value estimate. The Company also performs subsequent transaction testing. The Company performs annual due diligence of the third party pricing services. The Company’s due diligence procedures include assessing the vendor’s valuation qualifications, control environment, analysis of asset-class specific valuation methodologies and understanding of sources of market observable assumptions and unobservable assumptions, if any, employed in the valuation methodology. The Company also considers the results of its exception reporting controls and any resulting price challenges that arise.

See Note 10 for a description of the Company’s determination of the fair value of corporate debt securities, U.S. government and agencies obligations, common stocks and other structured investments.
 
Receivables
 
For receivables of the consolidated CDOs, the carrying value approximates fair value as the nature of these assets has historically been short term and the receivables have been collectible. The fair value of these receivables is classified as Level 2.
 
Other Assets
 
Other assets consist primarily of properties held in consolidated pooled investment vehicles managed by Threadneedle. The fair value of these properties is calculated by a third party appraisal service by discounting future cash flows generated by the expected market rental value for the property using the equivalent yield of a similar investment property. Inputs used in determining the equivalent yield and expected rental value of the property may include: rental cash flows, current occupancy, historical vacancy rates, tenant history and assumptions regarding how quickly the property can be occupied and at what rental rates. Management reviews the valuation report and assumptions used to ensure that the valuation was performed in accordance with applicable independence, appraisal and valuation standards. Given the significance of the unobservable inputs to these measurements, these assets are classified as Level 3.
 
Other assets of the consolidated CDO’s consist primarily of warrants. Warrants that are traded directly with the issuer are classified as Level 2 when the price is derived from observable market data. Warrants from an issuer whose securities are not priced in active markets are classified as Level 3.
 
Liabilities
 
Debt
 
The fair value of the CDOs’ debt is determined using a discounted cash flow model. Inputs used to determine the expected cash flows include assumptions about default, discount, prepayment and recovery rates of the CDOs’ underlying assets. Given the significance of the unobservable inputs to this fair value measurement, the fair value of the CDOs’ debt is classified as Level 3.
 
Other Liabilities
 
Other liabilities consist primarily of securities purchased but not yet settled held by consolidated CDOs. The carrying value approximates fair value as the nature of these liabilities has historically been short term. The fair value of these liabilities is classified as Level 2.
 
The Company has elected the fair value option for the financial assets and liabilities of the consolidated CDOs. Management believes that the use of the fair value option better matches the changes in fair value of assets and liabilities related to the CDOs.
 
The following table presents the fair value and unpaid principal balance of loans and debt for which the fair value option has been elected:
 
September 30, 2013
 
December 31, 2012
 
(in millions)
Syndicated loans
 

 
 

Unpaid principal balance
$
4,261

 
$
4,023

Excess unpaid principal over fair value
(55
)
 
(101
)
Fair value
$
4,206

 
$
3,922

Fair value of loans more than 90 days past due
$
24

 
$
34

Fair value of loans in nonaccrual status
24

 
34

Difference between fair value and unpaid principal of loans more than 90 days past due, loans in nonaccrual status or both
34

 
38

Debt
 

 
 

Unpaid principal balance
$
4,696

 
$
4,757

Excess unpaid principal over fair value
(237
)
 
(307
)
Fair value
$
4,459

 
$
4,450


Interest income from syndicated loans, bonds and structured investments is recorded based on contractual rates in net investment income. Gains and losses related to changes in the fair value of investments and gains and losses on sales of investments are also recorded in net investment income. Interest expense on debt is recorded in interest and debt expense with gains and losses related to changes in the fair value of debt recorded in net investment income.
 
Total net gains (losses) recognized in net investment income related to changes in the fair value of financial assets and liabilities for which the fair value option was elected were $32 million and $(8) million for the three months ended September 30, 2013 and 2012, respectively. Total net gains (losses) recognized in net investment income related to changes in the fair value of financial assets and liabilities for which the fair value option was elected were $23 million and $(34) million for the nine months ended September 30, 2013 and 2012, respectively. The majority of the syndicated loans and debt have floating rates; as such, changes in their fair values are primarily attributable to changes in credit spreads.
 
Debt of the consolidated investment entities and the stated interest rates were as follows:
 
Carrying Value
 
Weighted Average Interest Rate
 
September 30,
2013
 
December 31,
2012
 
September 30,
2013
 
December 31,
2012
 
(in millions)
 
 
 
 
Debt of consolidated CDOs due 2016-2025
$
4,459

 
$
4,450

 
1.0
%
 
0.9
%
Floating rate revolving credit borrowings due 2014
302

 
309

 
2.6

 
2.6

Floating rate revolving credit borrowings due 2015
95

 
104

 
2.4

 
2.4

Floating rate revolving credit borrowings due 2017
118

 
118

 
4.5

 
4.5

Floating rate revolving credit borrowings due 2018
268

 
—

 
3.5

 
—

Total
$
5,242

 
$
4,981

 
 

 
 


The debt of the consolidated CDOs has both fixed and floating interest rates, which range from 0% to 13.2%. The interest rates on the debt of CDOs are weighted average rates based on the outstanding principal and contractual interest rates. The carrying value of the debt of the consolidated CDOs represents the fair value of the aggregate debt. The carrying value of the floating rate revolving credit borrowings represents the outstanding principal amount of debt of certain consolidated pooled investment vehicles managed by Threadneedle. The fair value of this debt was $783 million and $531 million as of September 30, 2013 and December 31, 2012, respectively. The consolidated pooled investment vehicles have entered into interest rate swaps and collars to manage the interest rate exposure on the floating rate revolving credit borrowings. The fair value of these derivative instruments is recorded gross and was a liability of $11 million and $17 million at September 30, 2013 and December 31, 2012, respectively. The overall effective interest rate reflecting the impact of the derivative contracts was 4.3% and 4.8% as of September 30, 2013 and December 31, 2012, respectively.