MORTGAGE BANKING AND OTHER

9 Months Ended

Sep. 30, 2022

NOTE 6 - 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.

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


	Three Months Ended September 30,		Nine Months Ended September 30,
(in millions)	2022	2021	2022	2021
Cash proceeds from residential mortgage loans sold with servicing retained	$3,518	$9,024	$14,676	$28,601
Repurchased residential mortgages(1)	—	114	87	1,283
Gain on sales(2)	21	96	74	321
Contractually specified servicing, late and other ancillary fees(2)	75	63	213	181

(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 unpaid principal balance of residential mortgage loans related to our MSRs was $96.4 billion and $90.2 billion at September 30, 2022 and December 31, 2021, 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 September 30,		As of and for the Nine Months Ended September 30,
(in millions)	2022	2021	2022	2021
Fair value as of beginning of the period	$1,411	$902	$1,029	$658


Amounts capitalized	70	109	244	318
Servicing rights acquired	—	—	16	—
Changes in unpaid principal balance during the period(1)	(31)	(54)	(102)	(159)
Changes in fair value during the period(2)	74	21	337	161
Fair value at end of the period	$1,524	$978	$1,524	$978

(1) 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.

(2) 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 of an immediate 10% and 20% adverse change in key economic assumptions to the current fair value of MSRs. 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)	September 30, 2022	December 31, 2021
Fair value	$1,524	$1,029
Weighted average life (years)	9.2	6.4
Weighted average constant prepayment rate	6.8%	10.7%
Decline in fair value from 10% adverse change	$34	$45
Decline in fair value from 20% adverse change	$66	$87
Weighted average option adjusted spread	627 bps	596 bps
Decline in fair value from 10% adverse change	$42	$25
Decline in fair value from 20% adverse change	$85	$50

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 10 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)	September 30, 2022	December 31, 2021
Education	$621	$761
Commercial and industrial(1)	604	80
Leases(2)	354	—

(1) Includes $92 million of government guaranteed SBA loans sold to outside investors with servicing retained and $512 million of loans acquired in the Investors acquisition that were sold and are subject to a temporary service agreement set to expire in the fourth quarter of 2022.

(2) Represents leases acquired in the Investors acquisition that were sold and are subject to a temporary service agreement set to expire in the fourth quarter of 2022.