Huntington National Bank 2006 Annual Report Download - page 15

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED
–F AIR VALUE M EASUREMENTS — A significant portion of our assets is carried at fair value, including securities, derivatives,
mortgage servicing rights (MSRs) and trading assets. Additionally, a smaller portion is carried at the lower of fair value or cost,
including held-for-sale loans, while another portion is evaluated for impairment using fair value measurements. At
December 31, 2006, approximately $4.8 billion of our assets were recorded at either fair value or at the lower of fair value or
cost.
The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current
transaction between willing parties, other than in a forced or liquidation sale. The majority of assets reported at fair value are
based on quoted market prices or on internally developed models that utilize independently sourced market parameters,
including interest rate yield curves, option volatilities, and currency rates.
We estimate the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are
actively traded and have quoted market prices, quoted market prices are used for fair value. When observable market prices do
not exist, we estimate fair value. Our valuation methods consider factors such as liquidity and concentration concerns and, for
the derivatives portfolio, counterparty credit risk. Other factors such as model assumptions, market dislocations and
unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of
revenue or loss recorded for a particular position.
Trading securities and securities available-for-sale
Substantially all of our securities are valued based on quoted market prices. However, certain securities are less actively
traded. These securities do not always have quoted market prices. The determination of their fair value, therefore, requires
judgment, as this determination may require benchmarking to similar instruments or analyzing default and recovery rates.
Examples include certain collateralized mortgage and debt obligations and high-yield debt securities.
Our derivative positions are valued using internally developed models based on observable market parameters (parameters
that are actively quoted and can be validated to external sources) or model values where quoted market prices do not exist,
including industry-pricing services.
Loans held-for-sale
The fair value of loans in the held-for-sale portfolio is generally based on observable market prices of similar instruments. If
market prices are not available, fair value is determined using internally developed models, based on the estimated cash
flows, adjusted for credit risk. The credit risk adjustment is discounted using a rate that is appropriate for each maturity and
incorporates the effects of interest rate changes.
Goodwill and Intangible Assets
Goodwill and intangible assets represents the excess of the cost of an acquisition over the fair value of the net assets
acquired. Goodwill impairment testing is performed at the reporting unit level annually as of September 30th, or more
frequently if events or circumstances indicate possible impairment. Fair values of reporting units are determined using a
combination of a discounted cash flow analyses based on internal forecasts and market-based valuation multiples for
comparable businesses. No impairment was identified as a result of the testing performed during 2006 or 2005. Note 9 to
the Consolidated Financial Statements contains additional information regarding goodwill and the carrying values by lines of
business.
MSRs and other servicing rights
MSRs and certain other servicing rights do not trade in an active, open market with readily observable prices. While sales of
MSRs occur, the precise terms and conditions are typically not readily available. Therefore, we estimate the fair value of the
MSRs on a monthly basis using a third-party valuation software package. Fair value is estimated based upon discounted net
cash flows calculated from a combination of loan level data and market assumptions. The valuation software combines loans
based on common characteristics that impact servicing cash flows (investor, remittance cycle, interest rate, product type, etc.)
in order to project net cash flows.
Market valuation assumptions (including discount rate, servicing costs, etc.) are also populated within the software. Valuation
assumptions are periodically reviewed against available market data (e.g., broker surveys) for reasonableness and adjusted if
deemed appropriate. The recorded MSR asset balance is adjusted up or down to estimated fair value based upon the final
month-end valuation, which utilized the month-end rate curve and prepayment assumptions. Note 5 of the Notes to
Consolidated Financial Statements contains an analysis of the impact to the fair value of MSRs resulting from changes in the
estimates used by management.
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