PNC Bank 2006 Annual Report Download - page 88

functions. Software development costs incurred in the
planning and post-development project stages are charged to
noninterest expense. Costs associated with designing software
configuration and interfaces, installation, coding programs and
testing systems are capitalized and amortized using the
straight-line method over periods ranging from one to seven
years.
R EPURCHASE A ND R ESALE A GREEMENTS
Repurchase and resale agreements are treated as collateralized
financing transactions and are carried at the amounts at which
the securities will be subsequently reacquired or resold,
including accrued interest, as specified in the respective
agreements. Our policy is to take possession of securities
purchased under agreements to resell. We monitor the market
value of securities to be repurchased and resold and additional
collateral may be obtained where considered appropriate to
protect against credit exposure.
O THER C OMPREHENSIVE I NCOME
Other comprehensive income consists, on an after-tax basis,
primarily of unrealized gains or losses on securities available
for sale and derivatives designated as cash flow hedges, and
changes in pension, postretirement and postemployment
liability adjustments. Details of each component are included
in Note 22 Other Comprehensive Income.
T REASURY S TOCK
We record common stock purchased for treasury at cost. At
the date of subsequent reissue, the treasury stock account is
reduced by the cost of such stock on the first-in, first-out
basis.
D ERIVATIVE I NSTRUMENTS A ND H EDGING A CTIVITIES
We use a variety of financial derivatives as part of our overall
asset and liability risk management process to manage interest
rate, market and credit risk inherent in our business activities.
We use substantially all such instruments to manage risk
related to changes in interest rates. Interest rate and total
return swaps, interest rate caps and floors and futures
contracts are the primary instruments we use for interest rate
risk management.
Financial derivatives involve, to varying degrees, interest rate,
market and credit risk. We manage these risks as part of our
asset and liability management process and through credit
policies and procedures. We seek to minimize counterparty
credit risk by entering into transactions with only high-quality
institutions, establishing credit limits, and generally requiring
bilateral netting and collateral agreements.
We recognize all derivative instruments at fair value as either
assets or liabilities in other assets or other liabilities. The
accounting for changes in the fair value of a derivative
instrument depends on whether it has been designated and
qualifies as part of a hedging relationship. For derivatives not
designated as an accounting hedge, the gain or loss is
recognized in trading noninterest income.
For those derivative instruments that are designated and
qualify as hedging instruments, we must designate the hedging
instrument, based on the exposure being hedged, as a fair
value hedge, a cash flow hedge or a hedge of a net investment
in a foreign operation. We have no derivatives that hedge the
net investment in a foreign operation.
We formally document the relationship between the hedging
instruments and hedged items, as well as the risk management
objective and strategy before undertaking a hedge. To qualify
for hedge accounting, the derivatives and related hedged items
must be designated as a hedge. For hedging relationships in
which effectiveness is measured, we formally assess, both at
the inception of the hedge and on an ongoing basis, if the
derivatives are highly effective in offsetting changes in fair
values or cash flows of the hedged item. If it is determined
that the derivative instrument is not highly effective as a
hedge, hedge accounting is discontinued.
For derivatives that are designated as fair value hedges (i.e.,
hedging the exposure to changes in the fair value of an asset
or a liability attributable to a particular risk), changes in the
fair value of the hedging derivative are recognized in earnings
and offset by recognizing changes in the fair value of the
hedged item attributable to the hedged risk. To the extent the
hedge is ineffective, the changes in fair value will not offset
and the difference is reflected in the same financial statement
category as the hedged item.
For derivatives designated as cash flow hedges (i.e., hedging
the exposure to variability in expected future cash flows), the
effective portions of the gain or loss on derivatives are
reported as a component of accumulated other comprehensive
income or loss and subsequently reclassified in interest
income in the same period or periods during which the hedged
transaction affects earnings. As a result, the change in fair
value of any ineffective portion of the hedging derivative is
recognized immediately in earnings.
We discontinue hedge accounting when it is determined that
the derivative is no longer qualifying as an effective hedge;
the derivative expires or is sold, terminated or exercised; or
the derivative is de-designated as a fair value or cash flow
hedge or it is no longer probable that the forecasted
transaction will occur by the end of the originally specified
time period. If we determine that the derivative no longer
qualifies as a fair value or cash flow hedge and therefore
hedge accounting is discontinued, the derivative will continue
to be recorded on the balance sheet at its fair value with
changes in fair value included in current earnings. For a
discontinued fair value hedge, the previously hedged item is
no longer adjusted for changes in fair value.
When hedge accounting is discontinued because it is no longer
probable that a forecasted transaction will occur, the
derivative will continue to be recorded on the balance sheet at
its fair value with changes in fair value included in current
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