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Mortgage Banking and Servicing Rights
 12 Months Ended
Dec. 31, 2022
Mortgage Banking and Servicing Rights [Abstract]  
Mortgage Banking and Servicing Rights
5. Mortgage Banking and Servicing Rights


Mortgage banking activities primarily include residential mortgage originations and servicing.  As discussed in note 1 above, mortgage servicing rights (“MSRs”) are carried at fair 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 system used in this evaluation, Compass Point, attempts to quantify loan level idiosyncratic risk by calculating a risk derived value.  As a result, each loan’s unique characteristics determine the valuation assumptions ascribed to that loan.  Additionally, the computer valuation is based on key economic assumptions including the prepayment speeds of the underlying loans generated using the Andrew Davidson Prepayment Model, FHLMC/FNMA guidelines, 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 loan related fees.  Costs of servicing loans are charged to expense as incurred.  Changes in fair 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:

(in thousands)
Year Ended December 31
  
2022
    
2021
    
2020
  
Net gain on sale of mortgage loans held for sale
  
$
1,525
    
$
6,820
    
$
7,226
  
Net loan servicing income:
                        
Servicing fees
    
2,226
      
2,058
      
1,515
  
Late fees
    
78
      
67
      
52
  
Ancillary fees
    
94
      
848
      
1,310
  
Fair value adjustments
    
1,069
      
428
      
(1,064
)
Net loan servicing income
    
3,467
      
3,401
      
1,813
  
Mortgage banking income
  
$
4,992
    
$
10,221
    
$
9,039
  


Mortgage loans serviced for others are not included in the accompanying balance sheets.  Loans serviced for the benefit of others (primarily FHLMC) totaled $783 million, $807 million, and $650 million at December 31, 2022, 2021, and 2020, respectively.  Servicing loans for others generally consist 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 $3.0 million, $2.6 million, and $2.0 million at December 31, 2022, 2021, and 2020, respectively.


Activity for capitalized MSRs using the fair value method is as follows:

(in thousands)
  
2022
    
2021
    
2020
  
Fair value of MSRs, beginning of year
  
$
6,774
    
$
4,068
    
$
3,263
  
New servicing assets created
    
625
      
2,278
      
1,869
  
Change in fair value during the year due to:
                        
Time decay (1)
    
(450
)
    
(259
)
    
(135
)
Payoffs (2)
    
(429
)
    
(587
)
    
(766
)
Changes in valuation inputs or assumptions (3)
    
1,948
      
1,274
   
(163
)
Fair value of MSRs, end of year
  
$
8,468
    
$
6,774
    
$
4,068
  

(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.


The fair values of capitalized MSRs were $8.5 million, $6.8 million, and $4.1 million at December 31, 2022, 2021, and 2020, respectively.  Fair values for the years ended December 31, 2022, 2021, and 2020 were determined by third-party valuations with a resulting 10.0% average discount rate in 2022 compared to the 10.1% average discount rate over the prior two years, respectively, and weighted average default rates of 1.24%, 1.39%, and 1.67%, respectively.  Prepayment speeds generated using the Andrew Davidson Prepayment Model averaged 7.1%, 10.0%, and 15.7% at December 31, 2022, 2021, and 2020, 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 our MSR portfolio.