MORTGAGE BANKING AND OTHER

12 Months Ended

Dec. 31, 2021

NOTE 8 - MORTGAGE BANKING AND OTHER

The Company sells residential mortgages into the secondary market. The Company retains no beneficial interests in these sales, but may retain the servicing rights for the loans sold. The Company may exercise its option to repurchase eligible government guaranteed residential mortgages or may be 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.

Mortgage loans held for sale are accounted for at fair value on an individual loan basis. Changes in the fair value, and realized gains and losses on the sales of mortgage loans, are reported in mortgage banking income.

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


	Year Ended December 31,
(in millions)	2021	2020	2019
Cash proceeds from residential mortgage loans sold with servicing retained	$37,039	$33,221	$20,430
Repurchased residential mortgages(1)	1,381	—	—
Gain on sales(2)	382	895	251
Contractually specified servicing, late and other ancillary fees(2)	247	227	208

(1) Includes government insured or guaranteed loans eligible for repurchase through the exercise of our removal of account provision option.

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

The Company recognizes the right to service residential mortgage loans for others, or MSRs, as separate assets, which are presented in other assets on the Consolidated Balance Sheets, when purchased, or when servicing is contractually separated from the underlying mortgage loans by sale with servicing rights retained. MSRs are initially recorded at fair value. Subsequent to the initial recognition, MSRs are measured using either the fair value method or the amortization method. Effective January 1, 2020, the Company elected to account for all MSRs previously accounted for under the amortization method under the fair value method. Upon election, the Company recognized a cumulative effect adjustment to retained earnings of $6 million, net of taxes, equal to the difference between the carrying value of the MSRs and the fair value. Under the fair value method, the MSRs are recorded at fair value at each reporting date with any changes in fair value during the period recorded in mortgage banking fees in the Consolidated Statements of Operations. The unpaid principal balance of residential

mortgage loans related to our MSR was $90.2 billion and $81.2 billion as of December 31, 2021 and 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 Year Ended December 31,
(in millions)	2021	2020
Fair value as of beginning of the period	$658	$642
Transfers upon election of fair value method(1)	—	190
Fair value as of beginning of the period, adjusted	658	832

Amounts capitalized	419	324
Changes in unpaid principal balance during the period(2)	(212)	(196)
Changes in fair value during the period(3)	164	(302)
Fair value at end of the period	$1,029	$658

(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 the current MSR fair value of an immediate 10% and 20% adverse change in key economic assumptions. 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.


(dollars in millions)	December 31, 2021	December 31, 2020
Fair value	$1,029	$658
Weighted average life (years)	6.4	4.2
Weighted average constant prepayment rate	10.7%	17.3%
Decline in fair value from 10% adverse change	$45	$43
Decline in fair value from 20% adverse change	$87	$92
Weighted average option adjusted spread	596 bps	595 bps
Decline in fair value from 10% adverse change	$25	$14
Decline in fair value from 20% adverse change	$50	$29

The Company’s mortgage banking derivatives include commitments to originate mortgages held for sale, certain loan sale agreements, and other financial instruments that meet the definition of a derivative. Refer to Note 14 for additional information.

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)	December 31, 2021	December 31, 2020
Education	$761	$974
Commercial and industrial(1)	80	51

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