PNC Bank 2014 Annual Report Download - page 174

validated to external sources, including yield curves, implied
volatility or other market-related data. These instruments are
classified as Level 2.
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. In addition,
repurchased VA loans, where only a portion of the principal
will be reimbursed, are classified as Level 3. The fair value is
determined using a discounted cash flow calculation based on
our historical loss rate. Due to the unobservable nature of this
pool level approach, these loans are classified as Level 3.
Significant increases (decreases) in these assumptions would
result in a significantly lower (higher) fair value measurement.
During 2013, we elected to account for certain home equity
lines of credit at fair value. These loans 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 agreement and
occur typically after the loan is in default. Similar to existing
loans classified as Level 3 due to being repurchased and
unsalable, 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 is included in the Loans – Home equity line item
in Table 85 in this Note 7.
Significant inputs to the valuation of residential mortgage
loans include credit and liquidity discount, cumulative default
rate, loss severity and gross discount rate and are deemed
representative of current market conditions. Significant
increases (decreases) in an 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. On January 31, 2013, we transferred
.2 million shares to BlackRock pursuant to our obligation to
partially fund a portion of certain BlackRock LTIP programs.
After this transfer and at December 31, 2014, 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 BlackRock 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 PNC’s
deferred compensation, supplemental incentive savings plan
liabilities and certain stock based compensation awards that
are based on PNC’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 PNC’s stock and is recorded in either
Other Assets or Other Liabilities at fair value and is classified
as Level 2. In addition, deferred compensation and
supplemental incentive savings plan participants may also
invest based on fixed income and equity-based funds. PNC
utilizes a Rabbi Trust to hedge the returns by purchasing
similar 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. The other liabilities category
includes a contingent liability which is classified as Level 3.
All Level 3 other assets and liabilities are included in the
Insignificant Level 3 assets, net of liabilities line item in
Table 85 in this Note 7.
Other Borrowed Funds
During the first quarter of 2013, we elected to account for
certain other borrowed funds consisting primarily of secured
debt at fair value. These other borrowed funds are classified as
Level 3. Significant unobservable inputs for these borrowed
funds include credit and liquidity discount and spread over the
benchmark curve. Significant increases (decreases) in these
assumptions would result in significantly lower (higher) fair
value measurement.
Other borrowed funds also includes the related liability for
transferred loans over which PNC regained effective control
pursuant to ASC 860. These other borrowed funds are
classified as either Level 2 or Level 3 consistent with the
corresponding loans described above. All Level 3 amounts are
included in the Insignificant Level 3 assets, net of liabilities
line item in Table 85 in this Note 7.
156 The PNC Financial Services Group, Inc. – Form 10-K