Mortgage Servicing Rights

12 Months Ended

Dec. 31, 2015

Mortgage Servicing Rights

Mortgage-Backed Securities

7. Mortgage Servicing Rights

In connection with its acquisition of Pingora, as discussed in Note 1, the Company entered agreements with PLS to begin 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 year ended December 31, 2015.

Fair value, beginning of period	$	-
Purchases		259,215
Change in fair value due to:
Changes in valuation inputs or assumptions		13,598
Other changes, including realization of cash flows		(2,887	)
Fair value, end of period	$	269,926

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 December 31, 2015 and December 31, 2014.

	December 31, 2015
		Weighted-
Unobservable Input	Range	Average
Discount rate	10%-15%		10.4	%
Prepayment rate	5.6%-30.7%		11.9	%
Delinquency rate	0%-6.03%		1.4	%
Annual cost to service	$80-$101	$	88

The Company’s mortgage servicing income consisted of the following for the years ended December 31, 2015:

Servicing income	$	19,897
Ancillary income		214
Servicing income	$	20,111

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.