Note 8. Mortgage Servicing Rights

The Company records a separate servicing asset representing the right to service third-party loans. MSRs are initially recorded at their fair value as a component of the sale proceeds. The fair values of the MSRs are based on an analysis of discounted cash flows that incorporates estimates of (1) market servicing costs, (2) market-based estimates of ancillary servicing revenue, (3) market-based prepayment rates, and (4) market profit margins.

MSRs are subsequently measured at either fair value or amortized in proportion to, and over the period of, estimated net servicing income. The Company elects one of those methods on a class basis. A class is determined based on (1) the availability of market inputs used in determining the fair value of servicing assets, and/or (2) the Company’s method for managing the risks of servicing assets.

The Company had MSRs of $197.2 million and $247.7 million, respectively, at September 30, 2016 and December 31, 2015. Both period-end balances consisted of two classes of MSRs for which the Company separately managed the economic risk: residential MSRs and participation MSRs (i.e., MSRs on loans sold through participations).

The total unpaid principal balance of loans serviced for others was $25.0 billion and $24.2 billion at September 30, 2016 and December 31, 2015, respectively.

Residential MSRs are carried at fair value, with changes in fair value recorded as a component of non-interest income in each period. The Company uses various derivative instruments to mitigate the income statement-effect of changes in fair value due to changes in valuation inputs and assumptions regarding its residential MSRs. The effects of changes in the fair value of the derivatives are recorded as “Mortgage banking income,” which is included in “Non-interest income” in the Consolidated Statements of Income and Comprehensive Income. MSRs do not trade in an active open market with readily observable prices. Accordingly, the Company utilizes a third-party valuation specialist to determine the fair value of its MSRs. This specialist determines fair value based on the present value of estimated future net servicing income cash flows, and incorporates assumptions that market participants would use to estimate fair value, including estimates of prepayment speeds, discount rates, default rates, refinance rates, servicing costs, escrow account earnings, contractual servicing fee income, and ancillary income. The specialist and the Company evaluate, and periodically adjust, as necessary, these underlying inputs and assumptions to reflect market conditions and changes in the assumptions that a market participant would consider in valuing MSRs.

The value of residential MSRs at any given time is significantly affected by the mortgage interest rates that are then available in the marketplace; these, in turn, influence mortgage loan prepayment speeds. The rate of prepayment of residential loans serviced is the most significant estimate involved in the measurement process. Actual prepayment rates may differ from those projected by management due to changes in a variety of economic factors, including prevailing interest rates and the availability of alternative financing sources to borrowers.

During periods of declining interest rates, the value of residential MSRs generally declines as an increase in mortgage refinancing activity results in an increase in prepayments and a decrease in the carrying value of residential MSRs through a charge to earnings in the current period. Conversely, during periods of rising interest rates, the value of residential MSRs generally increases as mortgage refinancing activity declines and actual prepayments of the loans being serviced occur more slowly than expected. This results in the carrying value of residential MSRs and servicing income being higher than previously anticipated. Accordingly, the residential MSRs actually realized could differ from the amounts initially recorded.

Participation MSRs are initially carried at fair value and are subsequently amortized and carried at the lower of their fair value or amortized amount. The amortization is recorded in proportion to, and over the period of, estimated net servicing income, with impairment of those servicing assets evaluated through an assessment of their fair value via a discounted cash-flow method. The net carrying value is compared to the discounted estimated future net cash flows to determine whether adjustments should be made to carrying values or amortization schedules. Impairment of participation MSRs is recognized through a valuation allowance and a charge to current-period earnings if it is considered to be temporary or through a direct write-down of the asset and a charge to current-period earnings if it is considered other than temporary. The predominant risk characteristics of the underlying loans that are used to stratify the participation MSRs for measurement purposes generally include the (1) loan origination date, (2) loan rate, (3) loan type and size, (4) loan maturity date, and (5) geographic location. Changes in the carrying value of participation MSRs due to amortization or declines in fair value (i.e., impairment), if any, are reported in “Other income” in the period during which such changes occur. In the nine months ended September 30, 2016, there was no impairment related to the Company’s participation MSRs.

The following tables set forth the changes in the balances of residential MSRs and participation MSRs for the periods indicated:


	For the Three Months Ended
	September 30, 2016						September 30, 2015
(in thousands)	Residential			Participation			Residential			Participation
Carrying value, beginning of period	$	188,331		$	5,663		$	250,963		$	2,675
Additions		12,005			731			9,219			1,350
Increase (decrease) in fair value:
Due to changes in interest rates		5,668			—			(15,703	)		—
Due to model assumption changes ⁽¹⁾		—			—			(1,506	)		—
Due to loan payoffs		(12,818	)		—			(9,023	)		—
Due to passage of time and other changes		(1,767	)		—			(1,528	)		—
Amortization		—			(618	)		—			(229	)

Carrying value, end of period	$	191,419		$	5,776		$	232,422		$	3,796

(1)	Represents changes in fair value driven by changes to the inputs to the valuation model related to assumed prepayment speeds.


	For the Nine Months Ended
	September 30, 2016						September 30, 2015
(in thousands)	Residential			Participation			Residential			Participation
Carrying value, beginning of period	$	243,389		$	4,345		$	227,297		$	—
Additions		31,185			2,999			40,217			4,178
Decrease in fair value:
Due to changes in interest rates		(32,139	)		—			(844	)		—
Due to model assumption changes ⁽¹⁾		(13,088	)		—			(1,506	)		—
Due to loan payoffs		(31,939	)		—			(29,502	)		—
Due to passage of time and other changes		(5,989	)		—			(3,240	)		—
Amortization		—			(1,568	)		—			(382	)

Carrying value, end of period	$	191,419		$	5,776		$	232,422		$	3,796

(1)	Represents changes in fair value driven by changes to the inputs to the valuation model related to assumed prepayment speeds.

The following table presents the key assumptions used in calculating the fair value of the Company’s residential MSRs at the dates indicated:


	September 30, 2016			December 31, 2015
Expected weighted average life		72 months			92 months
Constant prepayment speed		11.25	%		7.35	%
Discount rate		10.02			10.01
Primary mortgage rate to refinance		3.56			4.03
Cost to service (per loan per year):
Current	$	64		$	63
30-59 days delinquent		201			213
60-89 days delinquent		351			313
90-119 days delinquent		451			413
120 days or more delinquent		851			563