PNC Bank 2015 Annual Report Download - page 170

price will have a negative impact on the fair value of the
swaps and vice versa, through its impact on periodic payments
due to the counterparty until the maturity dates of the swaps.
The fair values of our derivatives include a credit valuation
adjustment (CVA) to reflect our own and our counterparties’
nonperformance risk. Our CVA is computed using new loan
pricing and considers externally available bond spreads, in
conjunction with internal historical recovery observations.
Residential Mortgage Loans Held for Sale
We account for certain residential mortgage loans originated
for sale at fair value on a recurring basis. The election of the
fair value option aligns the accounting for the residential
mortgages with the related hedges. Additionally, we have
elected to account for loans repurchased due to breaches of
representations and warranties at fair value.
Residential mortgage loans are valued based on quoted market
prices, where available, prices for other traded mortgage loans
with similar characteristics, and purchase commitments and
bid information received from market participants. The prices
are adjusted as necessary to include the embedded servicing
value in the loans and to take into consideration the specific
characteristics of certain loans that are priced based on the
pricing of similar loans. These adjustments represent
unobservable inputs to the valuation but are not considered
significant given the relative insensitivity of the value to
changes in these inputs to the fair value of the loans.
Accordingly, the majority of residential mortgage loans held
for sale are classified as Level 2. This category also includes
repurchased and temporarily unsalable residential mortgage
loans. These loans are repurchased due to a breach of
representations and warranties in the loan sales agreement and
typically occur after the loan is in default. The temporarily
unsalable loans have an origination defect that makes them
currently unable to be sold into the performing loan sales
market. Because transaction details regarding sales of this type
of loan 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.
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 Servicing Rights
Commercial MSRs are carried at fair value on a recurring
basis. Assumptions incorporated into the commercial
valuation model reflect management’s best estimate of factors
that a market participant would use in valuing the commercial
MSRs. Although sales of commercial MSRs do occur,
commercial MSRs do not trade in an active, open market with
readily observable prices so the precise terms and conditions
of sales are not available. Due to the nature of the valuation
inputs and the limited availability of market pricing,
commercial MSRs are classified as Level 3.
The fair value of commercial MSRs is estimated by using a
discounted cash flow model incorporating unobservable inputs
for assumptions such as constant prepayment rates, discount
rates and other factors. Significant increases/(decreases) in
constant prepayment rates and discount rates would result in
significantly lower/(higher) commercial MSR value
determined based on current market conditions and
expectations.
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
152 The PNC Financial Services Group, Inc. – Form 10-K