PNC Bank 2012 Annual Report Download - page 195

Loans
Loans accounted for at fair value consist primarily of
residential mortgage loans. These loans are generally valued
similarly to residential mortgage loans held for sale and are
classified as Level 2. However, similar to residential mortgage
loans held for sale, if these loans are repurchased and
unsalable, they are classified as Level 3. This category also
includes repurchased brokered home equity loans. These loans
are repurchased due to a breach of representations or
warranties in the loan sales agreements and occur typically
after the loan is in default. The fair value price is based on
bids and market observations of transactions of similar
vintage. Because transaction details regarding the credit and
underwriting quality are often unavailable, unobservable bid
information from brokers and investors is heavily relied upon.
Accordingly, based on the significance of unobservable
inputs, these loans are classified as Level 3. The fair value of
these loans as of December 31, 2012 is 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. A significant input to the valuation
includes a credit and liquidity discount that is deemed
representative of current market conditions. Significant
increases (decreases) in this assumption would result in a
significantly lower (higher) fair value measurement.
BlackRock Series C Preferred Stock
We have elected to account for the shares of BlackRock Series
C Preferred Stock received in a stock exchange with
BlackRock at fair value. In September 2011, we delivered
approximately 1.3 million shares of BlackRock Series C
Preferred Stock pursuant to our obligation to partially fund a
portion of certain BlackRock LTIP programs. On January 31,
2013, we transferred an additional 205,350 shares to
BlackRock in connection with our obligation. After this
transfer, we hold approximately 1.3 million shares of
BlackRock Series C Preferred Stock which are available to
fund our obligation in connection with the BlackRock LTIP
programs. The Series C Preferred Stock economically hedges
the BlackRock LTIP liability that is accounted for as a
derivative. The fair value of the Series C Preferred Stock is
determined using a third-party modeling approach, which
includes both observable and unobservable inputs. This
approach considers expectations of a default/liquidation event
and the use of liquidity discounts based on our inability to sell
the security at a fair, open market price in a timely manner.
Although dividends are equal to common shares and other
preferred series, significant transfer restrictions exist on our
Series C shares for any purpose other than to satisfy the LTIP
obligation. Due to the significance of unobservable inputs, this
security is classified as Level 3. Significant increases
(decreases) in the liquidity discount would result in a
significantly lower (higher) asset value for the BlackRock
Series C and vice versa for the BlackRock LTIP liability.
Other Assets and Liabilities
We have entered into a prepaid forward contract with a
financial institution to mitigate the risk on a portion of the
Company’s deferred compensation, supplemental incentive
savings plan liabilities and certain stock based compensation
awards that are based on the Company’s stock price and are
subject to market risk. The prepaid forward contract is initially
valued at the transaction price and is subsequently valued by
reference to the market price of the Company’s stock and is
recorded in either Other Assets or Other Liabilities at fair
value. In addition, deferred compensation and supplemental
incentive savings plan participants may also invest based on
fixed income and equity-based funds. The Company utilizes a
Rabbi Trust to hedge the returns by purchasing the same funds
on which the participant returns are based. The Rabbi Trust
balances are recorded in Other Assets at fair value using the
quoted market price. These assets are primarily being
classified in Levels 1 and 2. The other asset category also
includes FHLB interests and the retained interests related to
the Small Business Administration (SBA) securitizations
which are classified as Level 3. All Level 3 other assets 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.
176 The PNC Financial Services Group, Inc. – Form 10-K