Servicing Assets

9 Months Ended

Sep. 30, 2020

Servicing Assets

Servicing Assets

(8)      Servicing Assets

The Corporation sells certain residential mortgage loans and the guaranteed portion of certain small business loans (“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 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 $298.7 million and $60.3 million of residential mortgage loans as of September 30, 2020 and December 31, 2019, respectively. During the three and nine months ended September 30, 2020, the Corporation recognized servicing fee income of $140 thousand and $247 thousand, respectively, compared to $25 thousand and $59 thousand during the three and nine months ended September 30, 2019, respectively.

Changes in the MSR balance are summarized as follows:

	Three Months Ended September 30,			Nine Months Ended September 30,
(dollars in thousands)	2020		2019	2020		2019
Balance at beginning of the period	$	1,294	236	$	446	232
Servicing rights capitalized		1,333	107		2,469	198
Amortization of servicing rights		(90)	(17)		(173)	(39)
Change in valuation allowance		102	(12)		(103)	(77)
Balance at end of the period	$	2,639	314	$	2,639	314

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

	Three Months Ended September 30,			Nine Months Ended September 30,
(dollars in thousands)	2020		2019	2020		2019
Valuation allowance, beginning of period	$	(303)	(65)	$	(98)	—
Impairment		—	(12)		(103)	(77)
Recovery		102	—		—	—
Valuation allowance, end of period	$	(201)	(77)	$	(201)	(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, 2020, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 12.00% and a discount rate equal to 9.00%.  At December 31, 2019, the key assumptions used to determine the fair value of the Corporation’s MSRs included a lifetime constant prepayment rate equal to 13.08% and a discount rate equal to 9.00%.

At September 30, 2020 and December 31, 2019, 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, 2020		December 31, 2019
Fair value of residential mortgage servicing rights	$	2,639	$	446
Weighted average life (years)		5.0		7.8
Prepayment speed		12.00%		13.08%
Impact on fair value:
10% adverse change	$	(99)	$	(19)
20% adverse change		(192)		(37)
Discount rate		9.00%		9.00%
Impact on fair value:
10% adverse change	$	(98)	$	(14)
20% adverse change		(189)		(27)

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 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 $44.8 million and $18.0 million of SBA loans, as of September 30, 2020 and December 31, 2019, respectively.  During the three and nine months ended September 30, 2020, the Corporation recognized servicing fee income of $49 thousand and $101 thousand, respectively.  During the three and nine months ended September 30, 2019, the Corporation recognized servicing fee income of $8 thousand.

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)	2020		2019	2020		2019
Balance at beginning of the period	$	632	133	$	337	—
Servicing rights capitalized		183	198		524	331
Amortization of servicing rights		(42)	(6)		(88)	(6)
Change in valuation allowance		14	(4)		14	(4)
Balance at end of the period	$	787	321	$	787	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)	2020		2019	2020		2019
Valuation allowance, beginning of period	$	(26)	—	$	(26)	—
Impairment		—	(4)		—	(4)
Recovery		14	—		14	—
Valuation allowance, end of period	$	(12)	(4)	$	(12)	(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, 2020, 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 12.79%, and a discount rate equal to 6.57%. At December 31, 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 10.77%, and a discount rate equal to 11.28%.

At September 30, 2020 and December 31, 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, 2020		December 31, 2019
Fair value of SBA loan servicing rights	$	889	$	337
Weighted average life (years)		3.6		4.3
Prepayment speed		12.79%		10.77%
Impact on fair value:
10% adverse change	$	(36)	$	(12)
20% adverse change		(69)		(23)
Discount rate		6.57%		11.28%
Impact on fair value:
10% adverse change	$	(23)	$	(9)
20% adverse change		(46)		(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.