PNC Bank 2012 Annual Report Download - page 225

There were no components of derivative gains or losses
excluded from the assessment of hedge effectiveness related
to either cash flow hedge strategy.
During 2012 and 2011, there were no gains or losses from
cash flow hedge derivatives reclassified to earnings because it
became probable that the original forecasted transaction would
not occur. The amount of cash flow hedge ineffectiveness
recognized in income for 2012 and 2011 was not material to
PNC’s results of operations.
Net Investment Hedges
We enter into foreign currency forward contracts to hedge
non-U.S. Dollar (USD) net investments in foreign subsidiaries
against adverse changes in foreign exchange rates. We assess
whether the hedging relationship is highly effective in
achieving offsetting changes in the value of the hedge and
hedged item by qualitatively verifying that the critical terms of
the hedge and hedged item match at the inception of the
hedging relationship and on an ongoing basis. There were no
components of derivative gains or losses excluded from the
assessment of the hedge effectiveness.
During 2012 and 2011, there was no net investment hedge
ineffectiveness.
Further detail regarding the notional amounts, fair values and
gains and losses recognized related to derivatives used in fair
value, cash flow, and net investment hedge strategies is
presented in the tables that follow.
D ERIVATIVES N OT D ESIGNATED IN H EDGE R ELATIONSHIPS
We also enter into derivatives that are not designated as
accounting hedges under GAAP.
The majority of these derivatives are used to manage risk
related to residential and commercial mortgage banking
activities and are considered economic hedges. Although these
derivatives are used to hedge risk, they are not designated as
accounting hedges because the contracts they are hedging are
typically also carried at fair value on the balance sheet,
resulting in symmetrical accounting treatment for both the
hedging instrument and the hedged item.
Our residential mortgage banking activities consist of
originating, selling and servicing mortgage loans. Residential
mortgage loans that will be sold in the secondary market, and
the related loan commitments, which are considered
derivatives, are accounted for at fair value. Changes in the fair
value of the loans and commitments due to interest rate risk
are hedged with forward contracts to sell mortgage-backed
securities, as well as US Treasury and Eurodollar futures and
options. Gains and losses on the loans and commitments held
for sale and the derivatives used to economically hedge them
are included in Residential mortgage noninterest income on
the Consolidated Income Statement.
We typically retain the servicing rights related to residential
mortgage loans that we sell. Residential mortgage servicing
rights are accounted for at fair value with changes in fair value
influenced primarily by changes in interest rates. Derivatives
used to hedge the fair value of residential mortgage servicing
rights include interest rate futures, swaps, 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.
Certain commercial mortgage loans held for sale are
accounted for at fair value. These loans, and the related loan
commitments, which are considered derivatives, are accounted
for at fair value. In addition we originate loans for sale into the
secondary market that are carried at the lower of cost or 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. Derivatives used to economically
hedge the change in value of commercial mortgage servicing
rights include interest rate swaps and futures. Gains or losses
on these derivatives are included in Corporate Services
noninterest income.
The residential and commercial mortgage 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,
foreign exchange contracts, and equity contracts. We
primarily manage our market risk exposure from customer
transactions by entering into a variety of hedging 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 and
include credit default swaps (CDS) used to mitigate the risk of
economic loss on a portion of our loan exposure. We also sold
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.
206 The PNC Financial Services Group, Inc. – Form 10-K