MORTGAGE BANKING AND OTHER

6 Months Ended

Jun. 30, 2021

NOTE 5 - MORTGAGE BANKING AND OTHER

The Company sells residential mortgages to GSEs and other parties, who may issue securities backed by pools of such loans. The Company retains no beneficial interests in these sales, but may retain the servicing rights for the loans sold. The Company is obligated to subsequently repurchase a loan if the purchaser discovers a representation or warranty violation such as noncompliance with eligibility or servicing requirements, or customer fraud that should have been identified in a loan file review.

The following table summarizes activity related to residential mortgage loans sold with servicing rights retained:


	Three Months Ended June 30,		Six Months Ended June 30,
(in millions)	2021	2020	2021	2020
Cash proceeds from residential mortgage loans sold with servicing retained	$10,540	$8,797	$19,577	$14,164
Gain on sales (1)	85	283	225	426
Contractually specified servicing, late and other ancillary fees (1)	60	55	118	113

(1) Reported in mortgage banking fees in the Consolidated Statements of Operations.

The unpaid principal balance of the related residential mortgage loans was $84.6 billion and $81.2 billion at June 30, 2021 and December 31, 2020, respectively. The Company manages an active hedging strategy to manage the risk associated with changes in the value of the MSR portfolio, which includes the purchase of freestanding derivatives.

The following table summarizes changes in MSRs recorded using the fair value method:


	As of and for the Three Months Ended June 30,		As of and for the Six Months Ended June 30,
(in millions)	2021	2020	2021	2020
Fair value as of beginning of the period	$893	$577	$658	$642
Transfers upon election of fair value method (1)	—	—	—	190
Fair value as of beginning of the period, adjusted	893	577	658	832
Amounts capitalized	122	86	209	153
Changes in unpaid principal balance during the period (2)	(47)	(46)	(105)	(86)
Changes in fair value during the period (3)	(66)	(49)	140	(331)
Fair value at end of the period	$902	$568	$902	$568

(1) Effective January 1, 2020, the Company elected to account for all MSRs previously accounted for under the amortization method under the fair value method.

(2) Represents changes in value of the MSRs due to i) passage of time including the impact from both regularly scheduled loan principal payments and partial

paydowns, and ii) loans that paid off during the period.

(3) Represents changes in value primarily driven by market conditions. These changes are recorded in mortgage banking fees in the Consolidated Statements of Operations.

The fair value of MSRs is estimated by using the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, contractual servicing fee income, servicing costs, default rates, ancillary income, and other economic factors, which are determined based on current market interest rates. The valuation does not attempt to forecast or predict the future direction of interest rates.

The sensitivity analysis below presents the impact to current fair value of an immediate 50 basis point and 100 basis point adverse change in key economic assumptions and the decline in fair value if the respective adverse change was realized. These sensitivities are hypothetical, with the effect of a variation in a particular assumption on the fair value of the MSRs calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (e.g., changes in interest rates, which drive changes in prepayment rates, could result in changes in the discount rates), which may amplify or counteract the sensitivities. The primary risk inherent in the Company’s MSRs is an increase in prepayments of the underlying mortgage loans serviced, which is largely dependent upon movements in market interest rates.


	June 30, 2021			December 31, 2020
	Actual	Decline in fair value due to		Actual	Decline in fair value due to
(dollars in millions)
Fair value	$902	50 bps adverse change	100 bps adverse change	$658	50 bps adverse change	100 bps adverse change
Weighted average life (in years)	5.7			4.2
Weighted average constant prepayment rate (1)	11.9%	$129	$273	17.3%	$122	$202
Weighted average option adjusted spread	581 bps	18	36	595 bps	12	24

(1) Estimated adverse change for the weighted average constant prepayment rate based on an adverse change in market interest rates.

Other Serviced Loans

From time to time, Citizens engages in other servicing relationships. The following table presents the unpaid principal balance of other serviced loans:


(in millions)	June 30, 2021	December 31, 2020
Education	$867	$974
Commercial (1)	61	51

(1) Represents the government guaranteed portion of SBA loans sold to outside investors.