PNC Bank 2012 Annual Report Download - page 93

Revenue Recognition
We earn net interest and noninterest income from various
sources, including:
• Lending,
• Securities portfolio,
• Asset management,
• Customer deposits,
• Loan sales and servicing,
• Brokerage services,
• Sale of loans and securities,
• Certain private equity activities, and
• Securities and derivatives trading activities, including
foreign exchange.
We also earn fees and commissions from issuing loan
commitments, standby letters of credit and financial
guarantees, selling various insurance products, providing
treasury management services, providing merger and
acquisition advisory and related services, and participating in
certain capital markets transactions. Revenue earned on
interest-earning assets, including the accretion of discounts
recognized on acquired or purchased loans recorded at fair
value, is recognized based on the constant effective yield of
the financial instrument.
The timing and amount of revenue that we recognize in any
period is dependent on estimates, judgments, assumptions, and
interpretation of contractual terms. Changes in these factors
can have a significant impact on revenue recognized in any
period due to changes in products, market conditions or
industry norms.
Residential And Commercial Mortgage Servicing Rights
We elect to measure our residential mortgage servicing rights
(MSRs) at fair value. This election was made to be consistent
with our risk management strategy to hedge changes in the
fair value of these assets as described below. The fair value of
residential MSRs is estimated by using a cash flow valuation
model which calculates the present value of estimated future
net servicing cash flows, taking into consideration actual and
expected mortgage loan prepayment rates, discount rates,
servicing costs, and other economic factors which are
determined based on current market conditions.
Assumptions incorporated into the residential MSRs valuation
model reflect management’s best estimate of factors that a
market participant would use in valuing the residential MSRs.
Although sales of residential MSRs do occur, residential
MSRs do not trade in an active market with readily observable
prices so the precise terms and conditions of sales are not
available. As a benchmark for the reasonableness of its
residential MSRs fair value, PNC obtains opinions of value
from independent parties (“brokers”). These brokers provided
a range (+/- 10 bps) based upon their own discounted cash
flow calculations of our portfolio that reflected conditions in
the secondary market, and any recently executed servicing
transactions. PNC compares its internally-developed
residential MSRs value to the ranges of values received from
the brokers. If our residential MSRs fair value falls outside of
the brokers’ ranges, management will assess whether a
valuation adjustment is warranted. For 2012 and 2011, PNC’s
residential MSRs value has not fallen outside of the brokers’
ranges. We consider our residential MSRs value to represent a
reasonable estimate of fair value.
Commercial MSRs are purchased or originated when loans are
sold with servicing retained. Commercial MSRs do not trade
in an active market with readily observable prices so the
precise terms and conditions of sales are not available.
Commercial MSRs are initially recorded at fair value and are
subsequently accounted for at the lower of amortized cost or
fair value. Commercial MSRs are periodically evaluated for
impairment. For purposes of impairment, the commercial
mortgage servicing rights are stratified based on asset type,
which characterizes the predominant risk of the underlying
financial asset. The fair value of commercial MSRs is
estimated by using a discounted cash flow model
incorporating inputs for assumptions as to constant
prepayment rates, discount rates and other factors determined
based on current market conditions and expectations.
PNC employs risk management strategies designed to protect
the value of MSRs from changes in interest rates and related
market factors. Residential MSRs values are economically
hedged with securities and 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 negatively
correlated to the change in fair value of the hedged residential
MSRs portfolio. The hedge relationships are actively managed
in response to changing market conditions over the life of the
residential MSRs assets. Commercial MSRs are economically
hedged at a macro level or with specific derivatives to protect
against a significant decline in interest rates. Selecting
appropriate financial instruments to economically hedge
residential or commercial MSRs requires significant
management judgment to assess how mortgage rates and
prepayment speeds could affect the future values of MSRs.
Hedging results can frequently be less predictable in the short
term, but over longer periods of time are expected to protect
the economic value of the MSRs.
The fair value of residential and commercial MSRs and
significant inputs to the valuation models as of December 31,
2012 are shown in Note 10 Goodwill and Other Intangible
Assets in the Notes To Consolidated Financial Statements in
Item 8 of this Report. The expected and actual rates of
mortgage loan prepayments are significant factors driving the
fair value. Management uses a third-party model to estimate
future residential loan prepayments and internal proprietary
models to estimate future commercial loan prepayments.
These models have been refined based on current market
conditions. Future interest rates are another important factor in
the valuation of MSRs. Management utilizes market implied
74 The PNC Financial Services Group, Inc. – Form 10-K