PNC Bank 2010 Annual Report Download - page 142
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Please find page 142 of the 2010 PNC Bank annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.certain instances, identifying a proxy security, market
transaction or index. For certain security types, primarily
non-agency residential securities, the fair value methodology
incorporates values obtained from a discounted cash flow
model. The modeling process incorporates assumptions
management believes market participants would use to value
the security under current market conditions. The assumptions
used include prepayment projections, credit loss assumptions,
and discount rates, which include a risk premium due to
liquidity and uncertainty that are based on both observable and
unobservable inputs. We use the discounted cash flow
analysis, in conjunction with other relevant pricing
information obtained from either pricing services or broker
quotes to establish the fair value that management believes is
representative under current market conditions. For purposes
of determining fair value at December 31, 2010 and
December 31, 2009, the relevant pricing service information
was the predominant input.
In the proxy approach, the proxy selected has similar credit,
tenor, duration, pricing and structuring attributes to the PNC
position. The price, market spread, or yield on the proxy is
then used to calculate an indicative market price for the
security. Depending on the nature of the PNC position and its
attributes relative to the proxy, management may make
additional adjustments to account for market conditions,
liquidity, and nonperformance risk, based on various inputs
including recent trades of similar securities, single dealer
quotes, and/or other observable and unobservable inputs.
Financial Derivatives
Exchange-traded derivatives are valued using quoted market
prices and are classified as Level 1. However, the majority of
derivatives that we enter into are executed over-the-counter
and are valued using internal models. Readily observable
market inputs to these models can be validated to external
sources, including industry pricing services, or corroborated
through recent trades, dealer quotes, yield curves, implied
volatility or other market-related data. Certain derivatives,
such as total rate of return swaps, are corroborated to the
CMBX index. These derivatives are classified as Level 2.
Derivatives priced using significant management judgment or
assumptions are classified as Level 3.
The fair values of our derivatives are adjusted for
nonperformance risk including credit risk as appropriate. Our
nonperformance risk adjustment is computed using new loan
pricing and considers externally available bond spreads, in
conjunction with internal historical recovery observations. The
credit risk adjustment is not currently material to the overall
derivatives valuation.
Residential Mortgage Loans Held for Sale
We have elected to account for certain residential mortgage
loans originated for sale on a recurring basis at fair value. At
December 31, 2009, all residential mortgage loans held for
sale were at fair value. Residential mortgage loans are valued
based on quoted market prices, where available, prices for
other traded mortgage loans with similar characteristics, and
purchase commitments and bid information received from
market participants. These loans are regularly traded in active
markets and observable pricing information is available from
market participants. The prices are adjusted as necessary to
include the embedded servicing value in the loans and to take
into consideration the specific characteristics of certain loans
that are priced based on the pricing of similar loans. These
adjustments represent unobservable inputs to the valuation but
are not considered significant to the fair value of the loans.
Accordingly, residential mortgage loans held for sale are
classified as Level 2.
Residential Mortgage Servicing Rights
Residential mortgage servicing rights (MSRs) are carried at
fair value on a recurring basis. Currently, these residential
MSRs do not trade in an active open market with readily
observable prices. Although sales of servicing assets do occur,
the precise terms and conditions typically would not be
available. Accordingly, management determines the fair value
of its residential MSRs using a discounted cash flow model
incorporating assumptions about loan prepayment rates,
discount rates, servicing costs, and other economic factors. As
part of the pricing process, management compares its fair
value estimates to third-party valuations on a quarterly basis to
assess the reasonableness of the fair values calculated by its
internal valuation models. Due to the nature of the valuation
inputs, residential MSRs are classified as Level 3.
Commercial Mortgage Loans Held for Sale
We account for certain commercial mortgage loans classified
as held for sale at fair value. The election of the fair value
option aligns the accounting for the commercial mortgages
with the related hedges. At origination, these loans were
intended for securitization.
We determine the fair value of commercial mortgage loans
held for sale by using a whole loan methodology. Fair value is
determined using sale valuation assumptions that management
believes a market participant would use in pricing the loans.
When available, valuation assumptions included observable
inputs based on whole loan sales. Adjustments are made to
these assumptions to account for situations when uncertainties
exist, including market conditions and liquidity. Credit risk is
included as part of our valuation process for these loans by
considering expected rates of return for market participants for
similar loans in the marketplace. Based on the significance of
unobservable inputs, we classified this portfolio as Level 3.
Equity Investments
The valuation of direct and indirect private equity investments
requires significant management judgment due to the absence
of quoted market prices, inherent lack of liquidity and the
long-term nature of such investments. The carrying values of
direct and affiliated partnership interests reflect the expected
exit price and are based on various techniques including
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