8. MORTGAGE BANKING ACTIVITIES

Activity for mortgage loans held for sale was as follows:

June 30, (in thousands)	2013			2012

Balance, January 1	$	10,614		$	4,392
Origination of mortgage loans held for sale	208,094			100,418
Proceeds from the sale of mortgage loans held for sale	(199,942		)	(104,439		)
Net gain on sale of mortgage loans held for sale	5,408			3,722

Balance, June 30	$	24,174		$	4,093

Mortgage Banking activities primarily include residential mortgage originations and servicing. The following table presents the components of Mortgage Banking income:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
(in thousands)	2013			2012			2013			2012

Net gain realized on sale of mortgage loans held for sale	$	3,439		$	1,642		$	5,677		$	3,185
Net change in fair value recognized on loans held for sale	(247		)	(5		)	(113		)	52
Net change in fair value recognized on rate lock commitments	(1,521		)	579			(388		)	523
Net change in fair value recognized on forward contracts	453			(182		)	232			(38		)
Net gain recognized	2,124			2,034			5,408			3,722

Loan servicing income	546			599			1,092			1,235
Amortization of mortgage servicing rights	(650		)	(712		)	(1,358		)	(1,671		)
Change in mortgage servicing rights valuation allowance	160			42			312			31
Net servicing income recognized	56			(71		)	46			(405		)

Total Mortgage Banking income	$	2,180		$	1,963		$	5,454		$	3,317

Activity for capitalized mortgage servicing rights was as follows:

June 30, (in thousands)	2013			2012

Balance, January 1	$	4,777		$	6,087
Additions	1,574			904
Amortized to expense	(1,358		)	(1,671		)
Change in valuation allowance	312			31

Balance, June 30	$	5,305		$	5,351

Activity for the valuation allowance for capitalized mortgage servicing rights was as follows:

June 30, (in thousands)	2013			2012

Balance, January 1	$	(345	)	$	(203	)
Additions	—			(11		)
Reductions credited to operations	312			42

Balance, June 30	$	(33	)	$	(172	)

Other information relating to mortgage servicing rights follows:

(dollars in thousands)	June 30, 2013		December 31, 2012

Fair value of mortgage servicing rights portfolio	$	6,861	$	5,446
Prepayment speed range	123% - 550%		112% - 550%
Discount rate	9%		9%
Weighted average default rate	1.50%		1.50%
Weighted average life in years	5.51		3.89

Mortgage Banking derivatives used in the ordinary course of business primarily consist of mandatory forward sales contracts and rate lock loan commitments. Mandatory forward contracts represent future commitments to deliver loans at a specified price and date and are used to manage interest rate risk on loan commitments and mortgage loans held for sale. Rate lock loan commitments represent commitments to fund loans at a specific rate. These derivatives involve underlying items, such as interest rates, and are designed to transfer risk. Substantially all of these instruments expire within 90 days from the date of issuance. Notional amounts are amounts on which calculations and payments are based, but which do not represent credit exposure, as credit exposure is limited to the amounts required to be received or paid.

Mandatory forward contracts also contain an element of risk in that the counterparties may be unable to meet the terms of such agreements. In the event the counterparties fail to deliver commitments or are unable to fulfill their obligations, the Bank could potentially incur significant additional costs by replacing the positions at then current market rates. The Bank manages its risk of exposure by limiting counterparties to those banks and institutions deemed appropriate by management and the Board of Directors. The Bank does not expect any counterparty to default on their obligations and therefore, the Bank does not expect to incur any cost related to counterparty default.

The Bank is exposed to interest rate risk on loans held for sale and rate lock loan commitments. As market interest rates fluctuate, the fair value of mortgage loans held for sale and rate lock commitments will decline or increase. To offset this interest rate risk, the Bank enters into derivatives such as mandatory forward contracts to sell loans. The fair value of these mandatory forward contracts will fluctuate as market interest rates fluctuate, and the change in the value of these instruments is expected to largely, though not entirely, offset the change in fair value of loans held for sale and rate lock commitments. The objective of this activity is to minimize the exposure to losses on rate loan lock commitments and loans held for sale due to market interest rate fluctuations. The net effect of derivatives on earnings will depend on risk management activities and a variety of other factors, including market interest rate volatility, the amount of rate lock commitments that close, the ability to fill the forward contracts before expiration, and the time period required to close and sell loans.

The following table includes the notional amounts and fair values of mortgage loans held for sale and mortgage banking derivatives as of the period ends presented:

	June 30, 2013				December 31, 2012
(in thousands)	Notional Amount		Fair Value		Notional Amount		Fair Value

Included in Mortgage loans held for sale:
Mortgage loans held for sale	$	23,710	$	24,174	$	10,037	$	10,614

Included in other assets:
Rate lock loan commitments	$	70,447	$	446	$	48,308	$	833
Mandatory forward contracts	44,247		279		36,675		47

Total included in other assets	$	114,694	$	725	$	84,983	$	880