PNC Bank 2010 Annual Report Download - page 141
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EASUREMENT
Fair value is defined in GAAP as the price that would be
received to sell an asset or the price paid to transfer a liability
on the measurement date. The standard focuses on the exit
price in the principal or most advantageous market for the
asset or liability in an orderly transaction between market
participants. GAAP establishes a fair value reporting
hierarchy to maximize the use of observable inputs when
measuring fair value and defines the three levels of inputs as
noted below.
Level 1
Quoted prices in active markets for identical assets or
liabilities. Level 1 assets and liabilities may include debt
securities, equity securities and listed derivative contracts that
are traded in an active exchange market and certain US
government agency securities that are actively traded in
over-the-counter markets.
Level 2
Observable inputs other than Level 1 such as: quoted prices
for similar assets or liabilities in active markets, quoted prices
for identical or similar assets or liabilities in markets that are
not active, or other inputs that are observable or can be
corroborated to observable market data for substantially the
full term of the asset or liability. Level 2 assets and liabilities
may include debt securities, equity securities and listed
derivative contracts with quoted prices that are traded in
markets that are not active, and certain debt and equity
securities and over-the-counter derivative contracts whose fair
value is determined using a pricing model without significant
unobservable inputs. This category generally includes agency
residential and commercial mortgage-backed debt securities,
asset-backed securities, corporate debt securities, residential
mortgage loans held for sale, and derivative contracts.
Level 3
Unobservable inputs that are supported by minimal or no
market activity and that are significant to the fair value of the
assets or liabilities. Level 3 assets and liabilities may include
financial instruments whose value is determined using pricing
models with internally developed assumptions, discounted
cash flow methodologies, or similar techniques, as well as
instruments for which the determination of fair value requires
significant management judgment or estimation. This category
generally includes certain available for sale and trading
securities, commercial mortgage loans held for sale, private
equity investments, residential mortgage servicing rights,
BlackRock Series C Preferred Stock and certain financial
derivative contracts. The available for sale and trading
securities within Level 3 include non-agency residential
mortgage-backed securities, auction rate securities, certain
private-issuer asset-backed securities and corporate debt
securities. Nonrecurring items, primarily certain nonaccrual
and other loans held for sale, commercial mortgage servicing
rights, equity investments and other assets are also included in
this category.
We characterize active markets as those where transaction
volumes are sufficient to provide objective pricing
information, with reasonably narrow bid/ask spreads and
where dealer quotes received do not vary widely and are based
on current information. Inactive markets are typically
characterized by low transaction volumes, price quotations
which vary substantially among market participants or are not
based on current information, wide bid/ask spreads, a
significant increase in implied liquidity risk premiums, yields,
or performance indicators for observed transactions or quoted
prices compared to historical periods, a significant decline or
absence of a market for new issuance, or any combination of
the above factors. We also consider nonperformance risks
including credit risk as part of our valuation methodology for
all assets and liabilities measured at fair value.
Any models used to determine fair values or to validate dealer
quotes based on the descriptions below are subject to review
and independent testing as part of our model validation and
internal control testing processes. Our Model Validation
Committee tests significant models on at least an annual basis.
In addition, we have teams, independent of the traders, verify
marks and assumptions used for valuations at each period end.
Securities Available for Sale and Trading Securities
Securities accounted for at fair value include both the
available for sale and trading portfolios. We use prices
obtained from pricing services, dealer quotes or recent trades
to determine the fair value of securities. For 59% of our
positions, we use prices obtained from pricing services
provided by third party vendors. For an additional 9% of our
positions, we use prices obtained from the pricing services as
the primary input into the valuation process. One of the
vendors’ prices are set with reference to market activity for
highly liquid assets such as agency mortgage-backed
securities, and matrix pricing for other assets, such as CMBS
and asset-backed securities. Another vendor primarily uses
pricing models considering adjustments for ratings, spreads,
matrix pricing and prepayments for the instruments we value
using this service, such as non-agency residential mortgage-
backed securities, agency adjustable rate mortgage securities,
agency CMOs and municipal bonds. Management uses
various methods and techniques to corroborate prices obtained
from pricing services and dealers, including reference to other
dealer or market quotes, by reviewing valuations of
comparable instruments, or by comparison to internal
valuations. Dealer quotes received are typically non-binding.
In circumstances where relevant market prices are limited or
unavailable, valuations may require significant management
judgments or adjustments to determine fair value. In these
cases, the securities are classified as Level 3.
The valuation techniques used for securities classified as
Level 3 include using a discounted cash flow approach or, in
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