PNC Bank 2010 Annual Report Download - page 70
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Please find page 70 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.securities and a portfolio of derivatives, including interest-rate
swaps, options, and forward mortgage-backed and futures
contracts. As interest rates change, these financial instruments
are expected to have changes in fair value which are
negatively correlated to the change in fair value of the hedged
MSR portfolio. The hedge relationships are actively managed
in response to changing market conditions over the life of the
MSR assets. Selecting appropriate financial instruments to
hedge this risk requires significant management judgment to
assess how mortgage rates and prepayment speeds could
affect the future values of MSRs. Hedging results can
frequently be volatile in the short term, but over longer
periods of time are expected to protect the economic value of
the MSR portfolio.
The fair value of residential MSRs and significant inputs to
the valuation model as of December 31, 2010 are shown in the
table below. The expected and actual rates of mortgage loan
prepayments are the most significant factors driving the fair
value. Management uses a third party model to estimate future
loan prepayments. This model has been refined based on
historical performance of PNC’s managed portfolio, as
adjusted for current market conditions. Future interest rates
are another important factor in the valuation of MSRs.
Management utilizes market implied forward interest rates to
estimate the future direction of mortgage and discount rates.
The forward rates utilized are derived from the current yield
curve for U.S. dollar interest rate swaps and are consistent
with pricing of capital markets instruments. Changes in the
shape and slope of the forward curve in future periods may
result in volatility in the fair value estimate.
Dollars in millions
Dec. 31,
2010
Dec. 31
2009
Fair value $1,033 $1,332
Weighted-average life (in years) (a) 5.8 4.5
Weighted-average constant prepayment
rate (a) 12.61% 19.92%
Spread over forward interest rate swap rates 12.18% 12.16%
(a) Changes in weighted-average life and weighted-average constant prepayment rate
reflect the cumulative impact of changes in rates, prepayment expectations and
model changes.
A sensitivity analysis of the hypothetical effect on the fair
value of MSRs to adverse changes in key assumptions is
presented below. These sensitivities do not include the impact
of the related hedging activities. Changes in fair value
generally cannot be extrapolated because the relationship of
the change in the assumption to the change in fair value may
not be linear. Also, the effect of a variation in a particular
assumption on the fair value of the MSRs is calculated
independently without changing any other assumption. In
reality, changes in one factor may result in changes in another
(for example, changes in mortgage interest rates, which drive
changes in prepayment rate estimates, could result in changes
in the interest rate spread), which could either magnify or
counteract the sensitivities.
Dollars in millions
Dec. 31,
2010
Dec. 31,
2009
Prepayment rate:
Decline in fair value from 10% adverse change $34 $56
Decline in fair value from 20% adverse change $65 $109
Spread over forward interest rate swap rates:
Decline in fair value from 10% adverse change $43 $55
Decline in fair value from 20% adverse change $83 $106
Income Taxes
In the normal course of business, we and our subsidiaries enter
into transactions for which the tax treatment is unclear or
subject to varying interpretations. In addition, filing
requirements, methods of filing and the calculation of taxable
income in various state and local jurisdictions are subject to
differing interpretations.
We evaluate and assess the relative risks and merits of the
appropriate tax treatment of transactions, filing positions,
filing methods and taxable income calculations after
considering statutes, regulations, judicial precedent, and other
information, and maintain tax accruals consistent with our
evaluation of these relative risks and merits. The result of our
evaluation and assessment is by its nature an estimate. We and
our subsidiaries are routinely subject to audit and challenges
from taxing authorities. In the event we resolve a challenge for
an amount different than amounts previously accrued, we will
account for the difference in the period in which we resolve
the matter.
Proposed Accounting Standards
The Financial Accounting Standards Board (FASB) issued
several Exposure Drafts for comment during 2010 as well as
the beginning of 2011, including, in May 2010, the Proposed
Accounting Standards Update—Accounting for Financial
Instruments and Revisions to the Accounting for Derivative
Instruments and Hedging Activities—Financial Instruments
(Topic 825) and Derivatives and Hedging (Topic 815). Under
the original proposal, most financial instruments (including
loans and securities) would be measured at fair value with
changes in fair value recognized in either net income or other
comprehensive income. Additional aspects of this proposal
included modifications for recognizing credit impairments,
changes to hedge accounting requirements, and disclosures of
both fair value and amortized cost information on the face of
the financial statements. At a recent FASB meeting, it was
tentatively decided that both the characteristics of the financial
asset and an entity’s business strategy should be used as
criteria in determining the classification and measurement of
financial assets as follows: 1.) Fair value measurement with
all changes in fair value recognized in net income; 2.) Fair
value measurement with qualifying changes in fair value
recognized in other comprehensive income; and 3.) Amortized
Cost. See the discussion below related to the Supplementary
Document issued by the FASB for further updates to this
Exposure Draft related to credit impairments.
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