PNC Bank 2015 Annual Report Download - page 172

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 76 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. As of both December 31, 2015 and
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. See Note 24 Subsequent Events for information on
the February 1, 2016 transfer of 0.5 million shares of the
Series C Preferred Stock to BlackRock to satisfy a portion of
our LTIP obligation. 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, and certain trading loans
which are classified as level 2. 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 76 in this Note 7.
Other Borrowed Funds
We have elected to account for other borrowed funds at fair
value consisting of 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 76 in this Note 7.
Other borrowed funds also included certain liabilities
consisting primarily of secured debt at fair value. As of
December 31, 2015, this secured debt was no longer
outstanding due to repurchases. These other borrowed funds
were 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 input assumptions would result in
significantly lower (higher) fair value measurement.
154 The PNC Financial Services Group, Inc. – Form 10-K