PNC Bank 2007 Annual Report Download - page 58

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Sensitivity results and market interest rate benchmarks for the
fourth quarters of 2007 and 2006 follow:
Interest Sensitivity Analysis Fourth
Quarter
2007
Fourth
Quarter
2006
Net Interest Income Sensitivity Simulation
Effect on net interest income in first year
from gradual interest rate change over
following 12 months of:
100 basis point increase (2.8)% (2.6)%
100 basis point decrease 2.9% 2.5%
Effect on net interest income in second year
from gradual interest rate change over
the preceding 12 months of:
100 basis point increase (6.4)% (5.5)%
100 basis point decrease 4.4% 3.7%
Duration of Equity Model
Base case duration of equity (in years): 2.1 1.5
Key Period-End Interest Rates
One month LIBOR 4.60% 5.32%
Three-year swap 3.91% 5.10%
In addition to measuring the effect on net interest income
assuming parallel changes in current interest rates, we
routinely simulate the effects of a number of nonparallel
interest rate environments. The following Net Interest Income
Sensitivity To Alternative Rate Scenarios table reflects the
percentage change in net interest income over the next two
12-month periods assuming (i) the PNC Economist’s most
likely rate forecast, (ii) implied market forward rates, and
(iii) a Two-Ten Inversion (a 200 basis point inversion between
two-year and ten-year rates superimposed on current base
rates) scenario. We are inherently sensitive to a flatter or
inverted yield curve.
Net Interest Income Sensitivity To Alternative Rate
Scenarios (Fourth Quarter 2007)
PNC
Economist
Market
Forward
Two-Ten
Inversion
First year sensitivity 6.4% 6.1% (8.7)%
Second year sensitivity 9.5% 11.0% (7.7)%
All changes in forecasted net interest income are relative to
results in a base rate scenario where current market rates are
assumed to remain unchanged over the forecast horizon.
When forecasting net interest income, we make assumptions
about interest rates and the shape of the yield curve, the
volume and characteristics of new business, and the behavior
of existing on- and off-balance sheet positions. These
assumptions determine the future level of simulated net
interest income in the base interest rate scenario and the other
interest rate scenarios presented in the following table. These
simulations assume that as assets and liabilities mature, they
are replaced or repriced at market rates.
The graph below presents the yield curves for the base rate
scenario and each of the alternate scenarios one year forward.
Alternate Interest Rate Scenarios
One Year Forward
3.0
4.0
5.0
6.0
1M LIBOR 2Y Swap 3Y Swap 5Y Swap
Base Rates PNC Economist Market Forward Two-Ten Inversion
Our risk position is currently liability sensitive which was the
objective of our recent balance sheet management strategies.
We believe that we have the deposit funding base and balance
sheet flexibility to adjust, where appropriate, to changing
interest rates and market conditions.
M
ARKET
R
ISK
M
ANAGEMENT
–T
RADING
R
ISK
Our trading activities primarily include customer-driven
trading in fixed income securities, equities, derivatives, and
foreign exchange contracts. They also include the
underwriting of fixed income and equity securities and
proprietary trading.
We use value-at-risk (“VaR”) as the primary means to
measure and monitor market risk in trading activities. The
Risk Committee of the Board establishes an enterprise-wide
VaR limit on our trading activities.
During 2007, our VaR ranged between $6.1 million and $12.8
million, averaging $8.5 million. This range reflected an
increase in market volatility.
To help ensure the integrity of the models used to calculate
VaR for each portfolio and enterprise-wide, we use a process
known as backtesting. The backtesting process consists of
comparing actual observations of trading-related gains or
losses against the VaR levels that were calculated at the close
of the prior day. We would expect a maximum of two to three
instances a year in which actual losses exceeded the prior day
VaR measure. During 2007, there were two such instances at
the enterprise-wide level.
53