Mortgage Banking and Servicing Rights

9 Months Ended

Sep. 30, 2011

Notes to Financial Statements [Abstract]

Note 5 - Mortgage Banking and Servicing Rights

Mortgage banking activities primarily include residential mortgage originations and servicing. Mortgage servicing rights ("MSRs") are carried at fair market value. The fair value is determined quarterly based on an independent third-party valuation using a discounted cash flow analysis and calculated using a computer pricing model. The computer valuation is based on key economic assumptions including the prepayment speeds of the underlying loans, the weighted-average life of the loan, the discount rate, the weighted-average coupon, and the weighted-average default rate, as applicable. Along with the gains received from the sale of loans, fees are received for servicing loans. These fees include late fees, which are recorded in interest income, and ancillary fees and monthly servicing fees, which are recorded in noninterest income. Costs of servicing loans are charged to expense as incurred. Changes in fair market value of the MSRs are reported as an increase or decrease to mortgage banking income.

The following table presents the components of mortgage banking income:

	Three Months Ended						Nine Months Ended
	September 30						September 30
(in thousands)	2011			2010			2011			2010
Net gain on sale of loans held for sale	$	438		$	575		$	1,166		$	1,354
Net loan servicing income (loss)
Servicing fees		270			280			805			828
Late fees		17			18			58			53
Ancillary fees		66			93			186			216
Fair value adjustments		(757	)		(213	)		(1,139	)		(1,194	)
Net loan servicing income (loss)		(404	)		178			(90	)		(97	)
Mortgage banking income (loss)	$	34		$	753		$	1,076		$	1,257

Mortgage loans serviced for others are not included in the accompanying balance sheets. Mortgage loans serviced for the benefit of others (primarily FHLMC) at September 30, 2011, December 31, 2010, and September 30, 2010, were $424 million, $425 million, and $444 million, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors, and processing foreclosures. Custodial escrow balances maintained in connection with the foregoing loan servicing, and included in demand deposits, were approximately $1.7 million at September 30, 2011, $0.5 million at December 31, 2010, and $1.7 million at September 30, 2010.

Activity for capitalized mortgage servicing rights using the fair value method was as follows:

	Nine Months Ended
	September 30
(in thousands)	2011			2010
Fair value, beginning of period	$	3,161		$	3,406
New servicing assets created		378			433
Change in fair value during the period due to:
Time decay (1)		(99	)		(105	)
Payoffs (2)		(83	)		(103	)
Changes in valuation inputs or assumptions (3)		(957	)		(986	)
Fair value, end of period	$	2,400		$	2,645

(1)	Represents decrease in value due to regularly scheduled loan principal payments and partial loan paydowns.

(2)	Represents decrease in value due to loans that paid off during the period.

(3)	Represents change in value resulting from market-driven changes in interest rates and prepayment speeds.

The fair value of capitalized mortgage servicing rights was $2.4 million at September 30, 2011 compared to $3.2 million at December 31, 2010 and $2.6 million at September 30, 2010. Fair values were determined by third-party valuations using a discount rate of 10.0% for the quarters ended September 30, 2011, December 31, 2010 and September 30, 2010, and weighted average default rates of 2.4%, 2.0%, and 1.84% respectively. Prepayment speeds generated using the Andrew Davidson Prepayment Model averaged 17.7%, 13.3%, and 17.4% at September 30, 2011, December 31, 2010, and September 30, 2010, respectively. MSR values are very sensitive to movement in interest rates as expected future net servicing income depends on the projected balance of the underlying loans, which can be greatly impacted by the level of prepayments. CTBI does not currently hedge against changes in the fair value of its MSR portfolio.