PNC Bank 2012 Annual Report Download - page 193

residential mortgage loan commitment asset (liability) result
when the probability of funding increases (decreases) and
when the embedded servicing value increases (decreases).
The fair value of commercial mortgage loan commitment
assets and liabilities as of December 31, 2012 are included in
the Insignificant Level 3 assets, net of liabilities line item in
Table 95: Fair Value Measurement – Recurring Quantitative
Information in this Note 9. Significant unobservable inputs for
commercial mortgage loan commitments include spread over
the benchmark U.S. Treasury interest rate and the embedded
servicing value. The spread over the benchmark curve reflects
management assumptions regarding credit and liquidity risks.
Embedded servicing value reflects the estimated value for
retaining the right to service the underlying loan once it is
sold. Significant increases (decreases) in the fair value of
commercial mortgage loan commitments result when the
spread over the benchmark curve decreases (increases) or the
embedded servicing value increases (decreases).
The fair value of interest rate option assets and liabilities as of
December 31, 2012 are included in the Insignificant Level 3
assets, net of liabilities line item in Table 95: Fair Value
Measurement – Recurring Quantitative Information in this
Note 9. The significant unobservable input used in the fair
value measurement of the interest rate options is expected
interest rate volatility. Significant increases (decreases) in
interest rate volatility would result in a significantly higher
(lower) fair value measurement.
The fair value of risk participation agreement assets and
liabilities as of December 31, 2012 are included in the
Insignificant Level 3 assets, net of liabilities line item in Table
95: Fair Value Measurement – Recurring Quantitative
Information in this Note 9. The significant unobservable
inputs used in the fair value measurement of risk participation
agreements are probability of default and loss severity.
Significant increases (decreases) in probability of default and
loss severity would result in a significantly higher (lower) fair
value measurement.
Significant unobservable inputs for the other contracts for
derivative liabilities include credit and liquidity discount and
spread over the benchmark curve that are deemed
representative of current market conditions. Significant
increases (decreases) in these assumptions would result in
significantly lower (higher) fair value measurement.
In connection with the sales of certain Visa Class B common
shares in 2012, we entered into swap agreements with the
purchaser of the shares to account for future changes in the
value of the Class B common shares resulting from changes in
the settlement of certain specified litigation and its effect on
the conversion rate of Class B common shares into Visa
Class A common shares and to make payments calculated by
reference to the market price of the Class A common shares.
At December 31, 2012, the estimated fair values of the swap
liabilities are classified as Level 3 instruments and included in
Table 95: Fair Value Measurement – Recurring Quantitative
Information in this Note 9. The fair values of the swap
agreements are determined using a discounted cash flow
methodology. The significant unobservable inputs to the
valuations are estimated changes in the conversion rate of the
Class B shares into Class A shares and the estimated future
price of the Class A shares. A decrease in the conversion rate
will have a negative impact on the fair value of the swaps and
vice versa. Independent of changes in the conversion rate, an
increase in the future Class A share price will have a negative
impact on the fair value of the swaps and vice versa, through
its impact on periodic payments due to the counterparty until
the maturity dates of the swaps.
The fair values of our derivatives are adjusted for
nonperformance risk through the calculation of our Credit
Valuation Adjustment (CVA). Our CVA is computed using
new loan pricing and considers externally available bond
spreads, in conjunction with internal historical recovery
observations.
Residential Mortgage Loans Held for Sale
We account for certain residential mortgage loans originated
for sale at fair value on a recurring basis. We have elected to
account for certain RBC Bank (USA) residential mortgage
loans held for sale at fair value. The election of the fair value
option aligns the accounting for the residential mortgages with
the related hedges. Additionally, with the exception of
repurchased FHA insured loans which are accounted for at
amortized cost, we have elected to account for loans
repurchased due to breaches of representations and warranties
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 given the relative insensitivity of the value to
changes in these inputs to the fair value of the loans.
Accordingly, the majority of residential mortgage loans held
for sale are classified as Level 2. This category also includes
repurchased and temporarily unsalable residential mortgage
loans. These loans are repurchased due to a breach of
representations and warranties in the loan sales agreement and
typically occur after the loan is in default. The temporarily
unsalable loans have an origination defect that makes them
currently unable to be sold into the performing loan sales
market. Because transaction details regarding sales of this type
of loan are often unavailable, unobservable bid information
174 The PNC Financial Services Group, Inc. – Form 10-K