PNC Bank 2010 Annual Report Download - page 169
Download and view the complete annual report
Please find page 169 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.used to hedge the fair value of residential mortgage servicing
rights include interest rate futures, swaps and options,
including caps, floors, and swaptions, and forward contracts to
purchase mortgage-backed securities. Gains and losses on
residential mortgage servicing rights and the related
derivatives used for hedging are included in residential
mortgage noninterest income.
Commercial mortgage loans are also sold into the secondary
market as part of our commercial mortgage banking activities
and are accounted for at fair value. Commitments related to
loans that will be sold are considered derivatives and are also
accounted for at fair value. Derivatives used to economically
hedge these loans and commitments from changes in fair
value due to interest rate risk and credit risk include forward
loan sale contracts, interest rate swaps, and credit default
swaps. Gains and losses on the commitments, loans and
derivatives are included in other noninterest income.
The residential and commercial loan commitments associated
with loans to be sold which are accounted for as derivatives
are valued based on the estimated fair value of the underlying
loan and the probability that the loan will fund within the
terms of the commitment. The fair value also takes into
account the fair value of the embedded servicing right.
We offer derivatives to our customers in connection with their
risk management needs. These derivatives primarily consist of
interest rate swaps, interest rate caps, floors, swaptions, and
foreign exchange and equity contracts. We primarily manage
our market risk exposure from customer transactions by
entering into offsetting derivative transactions with third-party
dealers. Gains and losses on customer-related derivatives are
included in other noninterest income.
The derivatives portfolio also includes derivatives used for
other risk management activities. These derivatives are
entered into based on stated risk management objectives.
This segment of the portfolio includes credit default swaps
(CDS) used to mitigate the risk of economic loss on a portion
of our loan exposure. We also sell loss protection to mitigate
the net premium cost and the impact of mark-to-market
accounting on CDS purchases to hedge the loan portfolio. The
fair values of these derivatives typically are based on related
credit spreads. Gains and losses on the derivatives entered into
for other risk management are included in other noninterest
income.
Included in the customer, mortgage banking risk management,
and other risk management portfolios are written interest-rate
caps and floors entered into with customers and for risk
management purposes. We receive an upfront premium from
the counterparty and are obligated to make payments to the
counterparty if the underlying market interest rate rises above
or falls below a certain level designated in the contract. At
both December 31, 2010 and 2009, the fair value of the
written caps and floors liability on our Consolidated Balance
Sheet was $15 million. Our ultimate obligation under written
options is based on future market conditions and is only
quantifiable at settlement.
Further detail regarding the derivatives not designated in
hedging relationships is presented in the tables that follow.
D
ERIVATIVE
C
OUNTERPARTY
C
REDIT
R
ISK
By entering into derivative contracts we are exposed to credit
risk. We seek to minimize credit risk through internal credit
approvals, limits, monitoring procedures, executing master
netting agreements and collateral requirements. We generally
enter into transactions with counterparties that carry high
quality credit ratings. Nonperformance risk including credit
risk is included in the determination of the estimated net fair
value.
We generally have established agreements with our major
derivative dealer counterparties that provide for exchanges of
marketable securities or cash to collateralize either party’s
positions. At December 31, 2010, we held cash, US
government securities and mortgage-backed securities totaling
$837 million under these agreements. We pledged cash and
mortgage-backed securities of $699 million under these
agreements. To the extent not netted against derivative fair
values under a master netting agreement, cash pledged is
included in Other assets and cash held is included in Other
borrowed funds on our Consolidated Balance Sheet.
The credit risk associated with derivatives executed with
customers is essentially the same as that involved in extending
loans and is subject to normal credit policies. We may obtain
collateral based on our assessment of the customer’s credit
quality.
We periodically enter into risk participation agreements to
share some of the credit exposure with other counterparties
related to interest rate derivative contracts or to take on credit
exposure to generate revenue. We will make/receive payments
under these agreements if a customer defaults on its obligation
to perform under certain derivative swap contracts. Risk
participation agreements are included in the derivatives table
that follows. Our exposure related to risk participations where
we sold protection is discussed in the Credit Derivatives
section below.
C
ONTINGENT
F
EATURES
Some of PNC’s derivative instruments contain provisions that
require PNC’s debt to maintain an investment grade credit
rating from each of the major credit rating agencies. If PNC’s
debt ratings were to fall below investment grade, it would be
in violation of these provisions, and the counterparties to the
derivative instruments could request immediate payment or
demand immediate and ongoing full overnight
collateralization on derivative instruments in net liability
positions.
161