Huntington National Bank 2014 Annual Report Download - page 100

94
Alt-A mortgage-backed and private-label CMO securities are collateralized by first-lien residential mortgage loans. The securities
valuation methodology incorporates values obtained from a third party pricing specialist using a discounted cash flow approach and a
proprietary pricing model and includes assumptions management believes market participants would use to value the securities under
current market conditions. The model uses inputs such as estimated prepayment speeds, losses, recoveries, default rates that are
implied by the underlying performance of collateral in the structure or similar structures, house price depreciation / appreciation rates
that are based upon macroeconomic forecasts and discount rates that are implied by market prices for similar securities with similar
collateral structures.
Pooled-trust-preferred securities are CDOs backed by a pool of debt securities issued by financial institutions. The collateral
generally consists of trust-preferred securities and subordinated debt securities issued by banks, bank holding companies, and
insurance companies. A full cash flow analysis is used to estimate fair values and assess impairment for each security within this
portfolio. We engage a third-party pricing specialist with direct industry experience in pooled-trust-preferred securities valuations to
provide assistance in estimating the fair value and expected cash flows for each security in this portfolio. The PD of each issuer and
the market discount rate are the most significant inputs in determining fair value. Management evaluates the PD assumptions
provided by the third-party pricing specialist by comparing the current PD to the assumptions used the previous quarter, actual
defaults and deferrals in the current period, and trend data on certain financial ratios of the issuers. Huntington also evaluates the
assumptions related to discount rates. Relying on cash flows is necessary because there was a lack of observable transactions in the
market and many of the original sponsors or dealers for these securities are no longer able to provide a fair value that is compliant with
ASC 820.
Derivatives used for hedging purposes
Derivatives designated as qualified hedges are tested for hedge effectiveness on a quarterly basis. Assessments are made at the
inception of the hedge and on a recurring basis to determine whether the derivative used in the hedging transaction has been and is
expected to continue to be highly effective in offsetting changes in fair values or cash flows of the hedged item. A statistical
regression analysis is performed to measure the effectiveness.
If, based on the assessment, a derivative is not expected to be a highly effective hedge or it has ceased to be a highly effective
hedge, hedge accounting is discontinued as of the quarter the hedge is not highly effective. As the statistical regression analysis
requires the use of estimates regarding the amount and timing of future cash flows which are sensitive to significant changes in future
periods based on changes in market rates, we consider this a critical accounting estimate.
Loans held for sale
Huntington has elected to apply the fair value option to certain residential mortgage loans that are classified as held for sale at
origination. The fair value is estimated based on security prices for similar product types.
Certain consumer and commercial loans are classified as held for sale and are accounted for at the lower of amortized cost or fair
value. The determination of fair value for these consumer loans is based on security prices for similar product types or discounted
expected cash flows, which takes into consideration factors such as future interest rates, prepayment speeds, default and loss curves,
and market discount rates. The determination of fair value for commercial loans takes into account factors such as the location and
appraised value of the related collateral, as well as the estimated cash flows from realization of the collateral.
Mortgage Servicing Rights
Retained rights to service mortgage loans are recognized as a separate and distinct asset at the time the loans are sold. Mortgage
servicing rights (“MSRs”) are initially recorded at fair value at the time the related loans are sold and subsequently re-measured at
each reporting date under either the fair value or amortization method. Any increase or decrease in fair value of MSRs accounted for
under the fair value method, as well as any amortization and/or impairment of MSRs recorded under the amortization method, is
reflected in earnings in the period that the changes occur. MSRs are subject to interest rate risk in that their fair value will fluctuate as
a result of changes in the interest rate environment. Fair value is determined based upon the application of an income approach
valuation model. The valuation model, maintained by an independent third party, incorporates assumptions in estimating future cash
flows. These assumptions include time decay, payoffs, and changes in valuation inputs and assumptions. The reasonableness of these
pricing models is validated on a minimum of a quarterly basis by at least one independent external service broker valuation. Because
the fair values of MSRs are significantly impacted by the use of estimates, the use of different assumption estimates can result in
different estimated fair values of those MSRs.