Transfers of financial assets and mortgage servicing assets

9 Months Ended

Sep. 30, 2018

Transfers and Servicing of Financial Assets

Transfers Of Financial Assets And Mortgage Servicing Assets

Note 12 – Transfers of financial assets and mortgage servicing assets

The Corporation typically transfers conforming residential mortgage loans in conjunction with GNMA and FNMA securitization transactions whereby the loans are exchanged for cash or securities and servicing rights. As seller, the Corporation has made certain representations and warranties with respect to the originally transferred loans and, in the past, has sold certain loans with credit recourse to a government-sponsored entity, namely FNMA. Refer to Note 21 to the Consolidated Financial Statements for a description of such arrangements.

No liabilities were incurred as a result of these securitizations during the quarters and nine months ended September 30, 2018 and 2017 because they did not contain any credit recourse arrangements. During the quarter and nine months ended September 30, 2018, the Corporation recorded a net gain of $2.9 million and $6.2 million, respectively (September 30, 2017 - $3.9 million and $15.0 million, respectively) related to the residential mortgage loans securitized.

The following tables present the initial fair value of the assets obtained as proceeds from residential mortgage loans securitized during the quarters and nine months ended September 30, 2018 and 2017:

		Proceeds Obtained During the Quarter Ended September 30, 2018
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Debt securities available-for-sale:
Mortgage-backed securities - FNMA	$	-	$	2,498	$	-	$	2,498
Total debt securities available-for-sale	$	-	$	2,498	$	-	$	2,498
Trading account debt securities:
Mortgage-backed securities - GNMA	$	-	$	109,911	$	-	$	109,911
Mortgage-backed securities - FNMA		-		23,625		-		23,625
Total trading account debt securities	$	-	$	133,536	$	-	$	133,536
Mortgage servicing rights	$	-	$	-	$	2,625	$	2,625
Total	$	-	$	136,034	$	2,625	$	138,659

		Proceeds Obtained During the Nine Months Ended September 30, 2018
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Debt securities available-for-sale:
Mortgage-backed securities - FNMA	$	-	$	9,458	$	-	$	9,458
Total debt securities available-for-sale	$	-	$	9,458	$	-	$	9,458
Trading account debt securities:
Mortgage-backed securities - GNMA	$	-	$	319,769	$	-	$	319,769
Mortgage-backed securities - FNMA		-		62,853		-		62,853
Total trading account debt securities	$	-	$	382,622	$	-	$	382,622
Mortgage servicing rights	$	-	$	-	$	7,198	$	7,198
Total	$	-	$	392,080	$	7,198	$	399,278

		Proceeds Obtained During the Quarter Ended September 30, 2017
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Debt securities available-for-sale:
Mortgage-backed securities - FNMA	$	-	$	4,329	$	-	$	4,329
Total debt securities available-for-sale	$	-	$	4,329	$	-	$	4,329
Trading account debt securities:
Mortgage-backed securities - GNMA	$	-	$	85,722	$	-	$	85,722
Mortgage-backed securities - FNMA		-		16,452		-		16,452
Total trading account debt securities	$	-	$	102,174	$	-	$	102,174
Mortgage servicing rights	$	-	$	-	$	1,588	$	1,588
Total	$	-	$	106,503	$	1,588	$	108,091

		Proceeds Obtained During the Nine Months Ended September 30, 2017
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Debt securities available-for-sale:
Mortgage-backed securities - FNMA	$	-	$	16,049	$	-	$	16,049
Total debt securities available-for-sale	$	-	$	16,049	$	-	$	16,049
Trading account debt securities:
Mortgage-backed securities - GNMA	$	-	$	368,660	$	-	$	368,660
Mortgage-backed securities - FNMA		-		69,798		-		69,798
Total trading account debt securities	$	-	$	438,458	$	-	$	438,458
Mortgage servicing rights	$	-	$	-	$	6,766	$	6,766
Total	$	-	$	454,507	$	6,766	$	461,273

During the nine months ended September 30, 2018, the Corporation retained servicing rights on whole loan sales involving approximately $43 million in principal balance outstanding (September 30, 2017 - $49 million), with realized gains of approximately $0.6 million (September 30, 2017 - gains of $1.8 million). All loan sales performed during the nine months ended September 30, 2018 and 2017 were without credit recourse agreements.

The Corporation recognizes as assets the rights to service loans for others, whether these rights are purchased or result from asset transfers such as sales and securitizations. These mortgage servicing rights (“MSR”) are measured at fair value.

The Corporation uses a discounted cash flow model to estimate the fair value of MSRs. The discounted cash flow model incorporates assumptions that market participants would use in estimating future net servicing income, including estimates of prepayment speeds, discount rate, cost to service, escrow account earnings, contractual servicing fee income, prepayment and late fees, among other considerations. Prepayment speeds are adjusted for the Corporation’s loan characteristics and portfolio behavior.

The following table presents the changes in MSRs measured using the fair value method for the nine months ended September 30, 2018 and 2017.

Residential MSRs
(In thousands)	September 30, 2018		September 30, 2017
Fair value at beginning of period	$	168,031	$	196,889
Additions		7,871		7,530
Changes due to payments on loans^[1]		(10,194)		(12,794)
Reduction due to loan repurchases		(2,929)		(1,605)
Changes in fair value due to changes in valuation model inputs or assumptions		-		(9,863)
Fair value at end of period	$	162,779	$	180,157
[1] Represents changes due to collection / realization of expected cash flows over time.

Residential mortgage loans serviced for others were $15.9 billion at September 30, 2018 (December 31, 2017 -$16.1 billion).

Net mortgage servicing fees, a component of mortgage banking activities in the Consolidated Statements of Operations, include the changes from period to period in the fair value of the MSRs, including changes due to collection / realization of expected cash flows. The banking subsidiaries receive servicing fees based on a percentage of the outstanding loan balance. These servicing fees are credited to income when they are collected. At September 30, 2018, those weighted average mortgage servicing fees were 0.30% (September 30, 2017 - 0.29%). Under these servicing agreements, the banking subsidiaries do not generally earn significant prepayment penalty fees on the underlying loans serviced.

The section below includes information on assumptions used in the valuation model of the MSRs, originated and purchased.

Key economic assumptions used in measuring the servicing rights derived from loans securitized or sold by the Corporation during the quarters and nine months ended September 30, 2018 and 2017 were as follows:

	Quarters ended				Nine months ended
	September 30, 2018		September 30, 2017		September 30, 2018		September 30, 2017
Prepayment speed	4.4	%	4.9	%	4.4	%	4.3	%
Weighted average life (in years)	11.4		10.5		11.4		10.9
Discount rate (annual rate)	11.0	%	10.9	%	11.1	%	10.9	%

Key economic assumptions used to estimate the fair value of MSRs derived from sales and securitizations of mortgage loans performed by the banking subsidiaries and servicing rights purchased from other financial institutions, and the sensitivity to immediate changes in those assumptions, were as follows as of the end of the periods reported:

		Originated MSRs						Purchased MSRs
		September 30,			December 31,			September 30,			December 31,
(In thousands)		2018			2017			2018			2017
Fair value of servicing rights		$	67,545		$	73,951		$	95,234		$	94,080
Weighted average life (in years)			7.2			7.3			6.7			6.5
Weighted average prepayment speed (annual rate)			5.0	%		5.1	%		5.4	%		5.7	%
	Impact on fair value of 10% adverse change	$	(1,371)		$	(1,503)		$	(2,023)		$	(2,070)
	Impact on fair value of 20% adverse change	$	(2,702)		$	(2,976)		$	(3,982)		$	(3,999)
Weighted average discount rate (annual rate)			11.5	%		11.5	%		11.0	%		11.0	%
	Impact on fair value of 10% adverse change	$	(3,005)		$	(3,091)		$	(4,071)		$	(3,785)
	Impact on fair value of 20% adverse change	$	(5,789)		$	(5,971)		$	(7,850)		$	(7,235)

The sensitivity analyses presented in the tables above for servicing rights are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 and 20 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in the sensitivity tables included herein, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.

At September 30, 2018, the Corporation serviced $1.4 billion (December 31, 2017 - $1.5 billion) in residential mortgage loans with credit recourse to the Corporation.

Under the GNMA securitizations, the Corporation, as servicer, has the right to repurchase (but not the obligation), at its option and without GNMA’s prior authorization, any loan that is collateral for a GNMA guaranteed mortgage-backed security when certain delinquency criteria are met. At the time that individual loans meet GNMA’s specified delinquency criteria and are eligible for repurchase, the Corporation is deemed to have regained effective control over these loans if the Corporation was the pool issuer. At September 30, 2018, the Corporation had recorded $195 million in mortgage loans on its Consolidated Statements of Financial Condition related to this buy-back option program (December 31, 2017 - $840 million). As long as the Corporation continues to service the loans that continue to be collateral in a GNMA guaranteed mortgage-backed security, the MSR is recognized by the Corporation. During the nine months ended September 30, 2018, the Corporation repurchased approximately $264 million (September 30, 2017 - $113 million) of mortgage loans under the GNMA buy-back option program. The determination to repurchase these loans was based on the economic benefits of the transaction, which results in a reduction of the servicing costs for these severely delinquent loans, mostly related to principal and interest advances. Furthermore, due to their guaranteed nature, the risk associated with the loans is minimal. The Corporation places these loans under its loss mitigation programs and once brought back to current status, these may be either retained in portfolio or re-sold in the secondary market.