PNC Bank 2014 Annual Report Download - page 173

Residential Mortgage Servicing Rights
Residential MSRs are carried at fair value on a recurring basis.
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, open 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 obtained 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 reflect 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 the periods presented,
PNC’s residential MSRs value did not fall outside of the
brokers’ ranges. We consider our residential MSRs value to
represent a reasonable estimate of fair value. Due to the nature
of the unobservable valuation inputs, residential MSRs are
classified as Level 3.
The significant unobservable inputs used in the fair value
measurement of residential MSRs are constant prepayment
rates and spread over the benchmark curve. Significant
increases (decreases) in prepayment rates and spread over the
benchmark curve would result in lower (higher) fair market
value of residential MSRs.
Commercial Mortgage Loans Held for Sale
We account for certain commercial mortgage loans classified
as held for sale in whole loan transactions at fair value. In
addition, as of September 1, 2014, we have elected to apply
the fair value option to commercial mortgage loans held for
sale to agencies. This election applies to all new commercial
mortgage loans held for sale originated for sale to the agencies
effective on or after September 1, 2014. The election of the
fair value option aligns the accounting for the commercial
mortgages with the related commitments to sell the loans.
We determine the fair value of commercial mortgage loans
held for sale based upon discounted cash flows. Fair value is
determined using sale valuation assumptions that management
believes a market participant would use in pricing the loans.
Valuation assumptions may include observable inputs based
on the benchmark interest rate swap curves, whole loan sales
and agency sales transactions. The significant unobservable
inputs are management’s assumption of the spread applied to
the benchmark rate and the estimated servicing cash flows for
loans sold to the agencies with servicing retained. The spread
over the benchmark curve includes management’s
assumptions of the impact of credit and liquidity risk.
Significant increases (decreases) in the spread applied to the
benchmark would result in a significantly lower (higher) asset
value. The wide range of the spread over the benchmark curve
is due to the varying risk and underlying property
characteristics within our portfolio. Significant increases
(decreases) in the estimated servicing cash flows would result
in significantly higher (lower) asset value. Based on the
significance of unobservable inputs, we classified this
portfolio as Level 3.
Equity Investments
The valuation of direct and indirect private equity investments
requires significant management judgment due to the absence
of quoted market prices, inherent lack of liquidity and the
long-term nature of such investments. The carrying values of
direct and affiliated partnership interests reflect the expected
exit price and are based on various techniques including
multiples of adjusted earnings of the entity, independent
appraisals, anticipated financing and sale transactions with
third parties, or the pricing used to value the entity in a recent
financing transaction. A multiple of adjusted earnings
calculation is the valuation technique utilized most frequently
and the multiple of earnings is the primary and most
significant unobservable input used in such calculation. The
multiple of earnings is utilized in conjunction with portfolio
company financial results and our ownership interest in
portfolio company securities to determine PNC’s interest in
the enterprise value of the portfolio company. Significant
decreases (increases) in the multiple of earnings could result
in a significantly lower (higher) fair value measurement. The
magnitude of the change in fair value is dependent on the
significance of the change in the multiple of earnings and the
significance of portfolio company adjusted earnings.
Valuation inputs or analysis are supported by portfolio
company or market documentation. Due to the size, private
and unique nature of each portfolio company, lack of liquidity
and the long-term nature of investments, relevant
benchmarking is not always feasible. A valuation committee
reviews the portfolio company valuations on a quarterly basis
and oversight is provided by senior management of the
business.
We value indirect investments in private equity funds based on
net asset value as provided in the financial statements that we
receive from their managers. Due to the time lag in our receipt
of the financial information and based on a review of
investments and valuation techniques applied, adjustments to
the manager-provided value are made when available recent
portfolio company information or market information indicates
a significant change in value from that provided by the manager
of the fund. These investments are classified as Level 3.
Customer Resale Agreements
We have elected to account for structured resale agreements,
which are economically hedged using free-standing financial
derivatives, at fair value. The fair value for structured resale
agreements is determined using a model that includes
observable market data such as interest rates as inputs.
Readily observable market inputs to this model can be
The PNC Financial Services Group, Inc. – Form 10-K 155