Mortgage Servicing Rights

9 Months Ended

Sep. 30, 2015

Mortgage Servicing Rights

Mortgage-Backed Securities

6.       Mortgage Servicing Rights

Through its acquisition of Pingora, as discussed in Note 1, the Company began investing in MSR during the third quarter of 2015.  As discussed in Note 2, MSR are carried at fair value.  The following table presents the rollforward of MSR for the periods presented.

	Three Months Ended September 30					Nine Months Ended September 30
	2015			2014		2015			2014
Fair value, beginning of period	$	-		$	-	$	-		$	-
Purchases		170,986			-		170,986			-
Settlements		-			-		-			-
Change in fair value		(539	)		-		(539	)		-
Fair value, end of period	$	170,447		$	-	$	170,447		$	-

The Company classifies its MSR as Level 3 in the fair value hierarchy.  Prices for these instruments are obtained from internal models and third-party pricing providers, both of which use significant unobservable inputs in their valuations.  These valuations are prepared on an instrument-by-instrument basis and primarily use discounted cash flow models that include unobservable market data inputs including prepayment rates, delinquency levels, and discount rates.  Model valuations are then compared to external indicators such as market price quotations from market makers for similar instruments and recent transactions in the same or similar instruments.  These valuations may also be discounted to reflect illiquidity and/or non-transferability, with the amount of such discount estimated by the third-party pricing provider in the absence of market information.  The valuation of MSR requires significant judgment by management and the third-party pricing provider.  Assumptions used for which there is a lack of observable inputs may significantly impact the resulting fair value and therefore the Company’s financial statements.  Management reviews the valuations received from the third-party pricing provider and uses them as a point of comparison to its internally modeled values.  As part of this review, prices are compared against other pricing indicators to ensure assumptions and pricing are reasonable.

The following table provides information about the significant unobservable inputs used in the Level 3 valuation of the Company’s MSR at September 30, 2015 and December 31, 2014.

	September 30, 2015				December 31, 2014
		Weighted-				Weighted-
Unobservable Input	Range	Average			Range	Average
Discount rate	10.0% - 11.0%		10.3	%	-	-
Prepayment rate	8.5% - 36.1%		11.1	%	-	-
Delinquency rate	0% - 1.3%		0.7	%	-	-

The Company’s mortgage servicing income and mortgage servicing expenses were as follows for the three and nine months ended September 30, 2015 and 2014.

	Three Months Ended September 30					Nine Months Ended September 30
	2015			2014		2015			2014
Servicing fee income	$	4,445		$	-	$	4,445		$	-
Ancillary fee income		117			-		117			-
Mortgage servicing fee income		4,562			-		4,562			-
Mortgage servicing expense		(464	)		-		(464	)		-
Change in representation and warranty obligations		(290	)		-		(290	)		-
Mortgage servicing rights income, net	$	3,808		$	-	$	3,808		$	-

A decline in interest rates could lead to higher-than-expected prepayments of mortgages underlying the Company’s MSR, which would result in a decline in the value of the MSR.  The Company’s investment in MBS mitigates the impact of such a decline on the Company’s total portfolio as a decline in interest rates generally leads to an increase in the value of the Company’s MBS.