Note 8 – Mortgage Servicing

Mortgage Servicing Rights – Amortization Method

The following table summarizes changes in the net carrying value of servicing assets that we account for using the amortization method for the nine months ended September 30:



	2016			2015
Beginning balance	$	377,379		$	1,820,091
Fair value election - transfer of MSRs carried at fair value (1)	—			(787,142		)
Additions recognized in connection with asset acquisitions	15,968			10,055
Additions recognized on the sale of mortgage loans	26,494			27,791
Sales	(23,521		)	(591,605		)
	396,320			479,190
Amortization (2)	(18,595		)	(88,188		)
Increase in impairment valuation allowance (3)	(37,164		)	(25,051		)
Ending balance	$	340,561		$	365,951

Estimated fair value at end of period	$	357,817		$	404,533

(1)

Effective January 1, 2015, we elected fair value accounting for a newly-created class of non-Agency MSRs, which were previously accounted for using the amortization method, based on a different strategy for managing the risks of the underlying portfolio compared to our other MSR classes. This irrevocable election applies to all subsequently acquired or originated servicing assets and liabilities that have characteristics consistent with this class. We recorded a cumulative-effect adjustment of $52.0 million (before deferred income taxes of $9.2 million) to retained earnings as of January 1, 2015 to reflect the excess of the fair value of these MSRs over their carrying amount. At December 31, 2014, the UPB of the loans related to the non-Agency MSRs for which the fair value election was made was $195.3 billion.

(2)

During 2016, principally in the third quarter, we participated in HUD’s Aged Delinquent Portfolio Loan Sale (ADPLS) program, which accelerates FHA insurance claims for a population of significantly delinquent FHA loans. The expedited claim filing process allows a servicer to reduce significantly its standard claim losses on accepted loans by shortening the servicing timeline and related expenses, some of which are not reimbursed by FHA insurance. Our participation required that we recognize $23.1 million of life-to-date losses on the claims filed in the third quarter. This loss is reported in Servicing and origination expense in the Unaudited Consolidated Statements of Operations. Because the MSRs related to the loans that were assigned to HUD had negative carrying values, our recognition of the losses on the loans reduced the negative carrying value of the MSRs thereby generating negative amortization expense for this population of MSRs. In the third quarter, this ADPLS-related negative amortization expense of $18.1 million exceeded the positive amortization expense on the remaining MSRs, generating net negative amortization for the quarter.


(3)	Impairment of MSRs is recognized in Servicing and origination expense. See Note 3 – Fair Value for additional information regarding impairment and the valuation allowance.

Mortgage Servicing Rights – Fair Value Measurement Method

The following table summarizes changes in the fair value of servicing assets that we account for at fair value on a recurring basis for the nine months ended September 30:



	2016									2015
	Agency			Non-Agency			Total			Agency			Non-Agency			Total
Beginning balance	$	15,071		$	746,119		$	761,190		$	93,901		$	—		$	93,901
Fair value election - transfer of MSRs carried at amortized cost	—			—			—			—			787,142			787,142
Cumulative effect of fair value election	—			—			—			—			52,015			52,015
Sales	(3		)	(145		)	(148		)	(70,084		)	(1,234		)	(71,318		)
Servicing transfers and adjustments	—			(1,326		)	(1,326		)	—			(1,139		)	(1,139		)
Changes in fair value (1):
Changes in valuation inputs or other assumptions	(4,654		)	—			(4,654		)	(2,592		)	12,031			9,439
Realization of expected future cash flows and other changes	(1,399		)	(57,555		)	(58,954		)	(6,808		)	(75,888		)	(82,696		)
Ending balance	$	9,015		$	687,093		$	696,108		$	14,417		$	772,927		$	787,344


(1)	Changes in fair value are recognized in Servicing and origination expense in the Unaudited Consolidated Statements of Operations.

Because the mortgages underlying these MSRs permit the borrowers to prepay the loans, the value of the MSRs generally tends to diminish in periods of declining interest rates, an improving housing market or expanded product availability (as prepayments increase) and increase in periods of rising interest rates, a deteriorating housing market or reduced product availability (as prepayments decrease). The following table summarizes the estimated change in the value of the MSRs that we carry at fair value as of September 30, 2016 given hypothetical shifts in lifetime prepayments and yield assumptions:



	Adverse change in fair value
	10%			20%
Weighted average prepayment speeds	$	(66,764	)	$	(135,780	)
Discount rate (option-adjusted spread)	$	(18,758	)	$	(34,142	)

The sensitivity analysis measures the potential impact on fair values based on hypothetical changes, which in the case of our portfolio at September 30, 2016 are increased prepayment speeds and a decrease in the yield assumption.

Portfolio of Assets Serviced

The following table presents the composition of our primary servicing and subservicing portfolios by type of property serviced as measured by UPB. The servicing portfolio represents loans for which we own the servicing rights while subservicing represents all other loans. The UPB of assets serviced for others are not included on our Unaudited Consolidated Balance Sheets.



	Residential		Commercial		Total
UPB at September 30, 2016
Servicing	$	206,615,310	$	—	$	206,615,310
Subservicing	10,276,692		151,432		10,428,124
	$	216,892,002	$	151,432	$	217,043,434
UPB at December 31, 2015
Servicing	$	230,132,729	$	—	$	230,132,729
Subservicing	20,833,383		105,268		20,938,651
	$	250,966,112	$	105,268	$	251,071,380
UPB at September 30, 2015
Servicing	$	238,108,447	$	—	$	238,108,447
Subservicing	49,960,702		180,877		50,141,579
	$	288,069,149	$	180,877	$	288,250,026

UPB serviced at September 30, 2016, December 31, 2015 and September 30, 2015 includes $123.2 billion, $137.1 billion and $146.0 billion, respectively, for which the Rights to MSRs have been sold to NRZ.

Residential assets serviced includes foreclosed real estate. Residential assets serviced also includes small-balance commercial assets with a UPB of $1.5 billion, $1.8 billion and $1.9 billion at September 30, 2016, December 31, 2015 and September 30, 2015, respectively. Commercial assets consist of large-balance foreclosed real estate.

A significant portion of the servicing agreements for our non-Agency servicing portfolio contain provisions where we could be terminated as servicer without compensation upon the failure of the serviced loans to meet certain portfolio delinquency or cumulative loss thresholds. As a result of the economic downturn beginning in 2007-2008, the portfolio delinquency and/or cumulative loss threshold provisions have been breached by many private-label securitizations in our non-Agency servicing portfolio. To date, terminations as servicer as a result of a breach of any of these provisions have been minimal.

Certain of our servicing agreements require that we maintain specified servicer ratings from rating agencies such as Moody’s and S&P. Out of 3,840 non-Agency servicing agreements, 729 with approximately $35.8 billion of UPB as of September 30, 2016 have minimum servicer ratings criteria. As a result of our current servicer ratings, termination rights have been triggered in 180 of these non-Agency servicing agreements. This represents approximately $11.5 billion in UPB as of September 30, 2016, or approximately 6.9% of our total non-Agency servicing portfolio.

In early 2015, we received notices terminating us as the servicer under four of our non-Agency servicing agreements due to rating downgrades. Pursuant to our servicing agreements, generally we are entitled to payment of accrued and unpaid servicing fees through termination as well as all advances and certain other previously unreimbursed amounts, although we lose the future servicing fee revenue. While the financial impact of the termination of servicing under these four servicing agreements was immaterial to our overall financial condition, as it represented only 0.17% of our overall servicing portfolio as of the time of transfer of servicing, we could be subject to further terminations either as a result of servicer ratings downgrades or future adverse actions by ratings agencies, which could have an adverse effect on our business, financing activities, financial condition and results of operations.

Downgrades in servicer ratings could adversely affect our ability to finance servicing advances and maintain our status as an approved servicer by Fannie Mae and Freddie Mac. The servicer rating requirements of Fannie Mae do not necessarily require or imply immediate action, as Fannie Mae has discretion with respect to whether we are in compliance with their requirements and what actions it deems appropriate under the circumstances in the event that we fall below their desired servicer ratings.

Servicing Revenue

The following table presents the components of servicing and subservicing fees for the periods ended September 30:



	Three Months				Nine Months
	2016		2015		2016		2015
Loan servicing and subservicing fees:
Servicing	$	232,013	$	274,089	$	706,194	$	904,062
Subservicing	5,000		14,354		17,494		48,004
	237,013		288,443		723,688		952,066
Home Affordable Modification Program (HAMP) fees	32,029		32,318		88,141		108,698
Late charges	15,225		19,162		51,301		63,557
Loan collection fees	6,746		6,682		20,860		25,176
Other	11,222		13,412		23,003		54,044
	$	302,235	$	360,017	$	906,993	$	1,203,541

Float balances (balances in custodial accounts, which represent collections of principal and interest that we receive from borrowers), are held in escrow by an unaffiliated bank and are excluded from our Unaudited Consolidated Balance Sheets. Float balances amounted to $2.6 billion and $3.1 billion at September 30, 2016 and September 30, 2015, respectively.

In addition to mortgage servicing and subservicing fees, in the third quarter of 2016, we executed clean-up calls on four, small-balance commercial mortgage securitization trusts, which resulted in our recognizing income of $12.8 million related to the value of the underlying collateral held by the trusts, including amounts on deposit in spread accounts (a form of cash collateral account). We reported this income in Other, net, (a component of Other income (expense)) in the Unaudited Consolidated Statements of Operations. Simultaneously with the execution of the clean-up call, we entered into a mortgage loan purchase agreement to sell the acquired commercial loans and foreclosed properties to a third party. The proceeds from the sale were used to fund the required payments to the holders of the debt securities issued by the trusts. The sales price of the loans represented a discount to the repurchase price of $2.5 million, which we reported in Gain on loans held for sale, net.