(8) Servicing Assets

The Corporation sells certain residential mortgage loans and the guaranteed portion of certain Small Business Administration (“SBA”) loans to third parties and retains servicing rights and receives servicing fees. All such transfers are accounted for as sales. When the Corporation sells a residential mortgage loan, it does not retain any portion of that loan and its continuing involvement in such transfers is limited to certain servicing responsibilities. While the Corporation may retain a portion of certain sold SBA loans, its continuing involvement in the portion of the loan that was sold is limited to certain servicing responsibilities. When the contractual servicing fees on loans sold with servicing retained are expected to be more than adequate compensation to a servicer for performing the servicing, a capitalized servicing asset is recognized. The Corporation accounts for the transfers and servicing of financial assets in accordance with ASC 860, Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.

Residential Mortgage Loans

The mortgage servicing rights (“MSRs”) are amortized to non-interest expense in proportion to, and over the period of, the estimated future net servicing life of the underlying assets. MSR’s are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the MSR. The Corporation serviced $45.1 million and $15.8 million of residential mortgage loans as of September 30, 2019 and 2018, respectively. During the three and nine months ended September 30, 2019, the Corporation recognized servicing fee income of $107 thousand and $198 thousand, respectively, compared to $90 thousand and $152 thousand during the three and nine months ended September 30, 2018, respectively.

Changes in the MSR balance are summarized as follows:


	Three Months Ended September 30,			Nine Months Ended September 30,
(dollars in thousands)	2019		2018	2019		2018
Balance at beginning of the period	$	236	62	$	232	—
Servicing rights capitalized		107	89		198	152
Amortization of servicing rights		(17)	(3)		(39)	(4)
Change in valuation allowance		(12)	—		(77)	—
Balance at end of the period	$	314	148	$	314	148

Activity in the valuation allowance for MSR’s was as follows:


	Three Months Ended September 30,			Nine Months Ended September 30,
(dollars in thousands)	2019		2018	2019		2018
Valuation allowance, beginning of period	$	(65)	—	$	—	—
Impairment		(12)	—		(77)	—
Recovery		—	—		—	—
Valuation allowance, end of period	$	(77)	—	$	(77)	—

The Corporation uses assumptions and estimates in determining the fair value of MSRs. These assumptions include prepayment speeds and discount rates. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At September 30, 2019, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 16.02% and a discount rate equal to 9.25%. At September 30, 2018, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 11.78% and a discount rate equal to 9.5%.

At September 30, 2019 and September 30, 2018, the sensitivity of the current fair value of the residential mortgage servicing rights to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table.



(dollars in thousands)	September 30, 2019		December 31, 2018
Fair value of residential mortgage servicing rights	$	314	$	213

Weighted average life (years)		7.4		3.4

Prepayment speed		16.02%		11.78%
Impact on fair value:
10% adverse change	$	(16)	$	(9)
20% adverse change		(30)		(17)

Discount rate		9.25%		9.50%
Impact on fair value:
10% adverse change	$	(9)	$	(8)
20% adverse change		(18)		(15)

The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the MSRs is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.

SBA Loans

SBA loan servicing assets are amortized to non-interest expense in proportion to, and over the period of, the estimated future net servicing life of the underlying assets. SBA loan servicing assets are evaluated quarterly for impairment based upon the fair value of the rights as compared to their amortized cost. Impairment is recognized on the income statement to the extent the fair value is less than the capitalized amount of the SBA loan servicing asset. The Corporation serviced $15.4 million of SBA loans, as of September 30, 2019 and no SBA loans, as of September 30, 2018. During the three and nine months ended September 30, 2019, the Corporation recognized servicing fee income of $8 thousand in both periods.

Changes in the SBA loan servicing asset balance are summarized as follows:


	Three Months Ended September 30,			Nine Months Ended September 30,
(dollars in thousands)	2019		2018	2019		2018
Balance at beginning of the period	$	133	—	$	—	—
Servicing rights capitalized		198	—		331	—
Amortization of servicing rights		(6)	—		(6)	—
Change in valuation allowance		(4)	—		(4)	—
Balance at end of the period	$	321	—	$	321	—

Activity in the valuation allowance for SBA loan servicing assets was as follows:


	Three Months Ended September 30,			Nine Months Ended September 30,
(dollars in thousands)	2019		2018	2019		2018
Valuation allowance, beginning of period	$	—	—	$	—	—
Impairment		(4)	—		(4)	—
Recovery		—	—		—	—
Valuation allowance, end of period	$	(4)	—	$	(4)	—

The Corporation uses assumptions and estimates in determining the fair value of SBA loan servicing rights. These assumptions include prepayment speeds, discount rates, and other assumptions. The assumptions used in the valuation were based on input from buyers, brokers and other qualified personnel, as well as market knowledge. At September 30, 2019, the key assumptions used to determine the fair value of the Corporation’s SBA loan servicing rights included a lifetime constant prepayment rate equal to 10.34%, and a discount rate equal to 8.88%. The Corporation did not service SBA loans at September 30, 2018.

At September 30, 2019, the sensitivity of the current fair value of the SBA loan servicing rights to immediate 10% and 20% favorable and unfavorable changes in key economic assumptions are included in the following table.



(dollars in thousands)	September 30, 2019
Fair value of SBA loan servicing rights	$	321

Weighted average life (years)		4.5

Prepayment speed		10.34%
Impact on fair value:
10% adverse change	$	(11)
20% adverse change		(21)

Discount rate		8.88%
Impact on fair value:
10% adverse change	$	(9)
20% adverse change		(18)

The sensitivity calculations above are hypothetical and should not be considered to be predictive of future performance. As indicated, changes in fair value based on adverse changes in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of an adverse variation in a particular assumption on the fair value of the SBA servicing rights is calculated without changing any other assumption; while in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments), which may magnify or counteract the effect of the change.