PNC Bank 2014 Annual Report Download - page 170

significant increase in implied liquidity risk premiums, yields,
or performance indicators for observed transactions or quoted
prices compared to historical periods, a significant decline or
absence of a market for new issuance, or any combination of
the above factors. We also consider nonperformance risks
including credit risk as part of our valuation methodology for
all assets and liabilities measured at fair value.
Any models used to determine fair values or to validate dealer
quotes based on the descriptions below are subject to review
and independent testing as part of our model validation and
internal control testing processes. Our Model Risk
Management Committee reviews significant models on at
least an annual basis. In addition, the Valuation Committee
approves valuation methodologies and reviews the results of
independent valuation reviews and processes for assets and
liabilities measured at fair value on a recurring basis.
Assets and liabilities measured at fair value, by their nature,
result in a higher degree of financial statement volatility. Assets
and liabilities classified within Level 3 inherently require the
use of various assumptions, estimates and judgments when
measuring their fair value. As observable market activity is
commonly not available to use when estimating the fair value of
Level 3 assets and liabilities, we must estimate fair value using
various modeling techniques. These techniques include the use
of a variety of inputs/assumptions including credit quality,
liquidity, interest rates or other relevant inputs across the entire
population of our Level 3 assets and liabilities. Changes in the
significant underlying factors or assumptions (either an increase
or a decrease) in any of these areas underlying our estimates
may result in a significant increase/decrease in the Level 3 fair
value measurement of a particular asset and/or liability from
period to period.
Financial Instruments Accounted For at Fair Value on
a Recurring Basis
Securities Available for Sale and Trading Securities
Securities accounted for at fair value include both the available
for sale and trading portfolios. We primarily use prices obtained
from pricing services, dealer quotes, or recent trades to determine
the fair value of securities. As of December 31, 2014, 78% of the
positions in these portfolios were priced by using pricing services
provided by third-party vendors. The third-party vendors use a
variety of methods when pricing securities that incorporate
relevant market data to arrive at an estimate of what a buyer in
the marketplace would pay for a security under current market
conditions. One of the vendor’s prices are set with reference to
market activity for highly liquid assets, such as U.S. Treasury and
agency securities and agency residential mortgage-backed
securities, and matrix pricing for other asset classes, such as
commercial mortgage-backed and other asset-backed securities.
Another vendor primarily uses discounted cash flow pricing
models considering adjustments for spreads and prepayments for
the instruments we value using this service, such as non-agency
residential mortgage-backed securities, agency adjustable rate
mortgage securities, agency collateralized mortgage obligations
(CMOs), commercial mortgage-backed securities and municipal
bonds. The vendors we use provide pricing services on a global
basis and have quality management processes in place to monitor
the integrity of the valuation inputs and the prices provided to
users, including procedures to consider and incorporate
information received from pricing service users who may
challenge a price. We monitor and validate the reliability of
vendor pricing on an ongoing basis through pricing methodology
reviews, by performing detailed reviews of the assumptions and
inputs used by the vendor to price individual securities, and
through price validation testing. Price validation testing is
performed independent of the risk-taking function and involves
corroborating the prices received from third-party vendors with
prices from another third-party source, by reviewing valuations of
comparable instruments, by comparison to internal valuations, or
by reference to recent sales of similar securities. Securities not
priced by one of our pricing vendors may be valued using a
dealer quote. Dealer quotes received are typically non-binding.
Securities priced using a dealer quote are subject to corroboration
either with another dealer quote, by comparison to similar
securities priced by either a third-party vendor or another dealer,
or through internal valuation in order to validate that the quote is
representative of the market. Security prices are also validated
through actual cash settlement upon sale of a security.
Securities are classified within the fair value hierarchy after
giving consideration to the activity level in the market for the
security type and the observability of the inputs used to
determine the fair value. When a quoted price in an active
market exists for the identical security, this price is used to
determine fair value and the security is classified within Level
1 of the hierarchy. Level 1 securities include certain U.S.
Treasury securities and exchange-traded equities. When a
quoted price in an active market for the identical security is
not available, fair value is estimated using either an alternative
market approach, such as a recent trade or matrix pricing, or
an income approach, such as a discounted cash flow pricing
model. If the inputs to the valuation are based primarily on
market observable information, then the security is classified
within Level 2 of the hierarchy. Level 2 securities include
agency debt securities, agency residential mortgage-backed
securities, agency and non-agency commercial mortgage-
backed securities, certain non-agency residential mortgage-
backed securities, asset-backed securities collateralized by
non-mortgage-related consumer loans, municipal securities,
and other debt securities. Level 2 securities are predominantly
priced by third parties, either a pricing vendor or dealer.
In certain cases where there is limited activity or less
transparency around the inputs to the valuation, securities are
classified within Level 3 of the hierarchy. Securities classified
as Level 3 consist primarily of non-agency residential
mortgage-backed and asset-backed securities collateralized by
first- and second-lien residential mortgage loans. Fair value
152 The PNC Financial Services Group, Inc. – Form 10-K