Quarterly report pursuant to Section 13 or 15(d)

Mortgage Servicing Rights

v3.5.0.2
Mortgage Servicing Rights
 9 Months Ended
Sep. 30, 2016
Transfers and Servicing [Abstract]  
Mortgage Servicing Rights
NOTE 17 – Mortgage Servicing Rights

The Corporation accounts for consumer MSRs at fair value, with changes in fair value primarily recorded in mortgage banking income in the Consolidated Statement of Income. The Corporation manages the risk in these MSRs with derivatives such as options and interest rate swaps, which are not designated as accounting hedges, as well as securities including MBS and U.S. Treasury securities. The securities used to manage the risk in the MSRs are classified in other assets, with changes in the fair value of the securities and the related interest income recorded in mortgage banking income.

The table below presents activity for residential mortgage and home equity MSRs for the three and nine months ended September 30, 2016 and 2015.

Rollforward of Mortgage Servicing Rights
 
 
 
 
 
 
 
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
(Dollars in millions)
2016
 
2015
 
2016
 
2015
Balance, beginning of period
$
2,269

 
$
3,521

 
$
3,087

 
$
3,530

Additions
101

 
185

 
307

 
568

Sales
—

 
(87
)
 
—

 
(399
)
Amortization of expected cash flows (1)
(206
)
 
(213
)
 
(622
)
 
(666
)
Changes in fair value due to changes in inputs and assumptions (2)
313

 
(363
)
 
(295
)
 
10

Balance, September 30 (3)
$
2,477

 
$
3,043

 
$
2,477

 
$
3,043

Mortgage loans serviced for investors (in billions)
$
355

 
$
408

 
$
355

 
$
408


(1) 
Represents the net change in fair value of the MSR asset due to the recognition of modeled cash flows and the passage of time.
(2) 
These amounts reflect the changes in modeled MSR fair value due to observed changes in interest rates, volatility, spreads, and the shape of the forward swap curve; periodic adjustments to valuation based on third-party price discovery; and periodic adjustments to the valuation model and other cash flow assumptions.
(3) 
At September 30, 2016, includes the $1.8 billion core MSR portfolio held in Consumer Banking, the $226 million non-core MSR portfolio held in All Other and the $466 million non-U.S. MSR portfolio held in Global Markets compared to $2.3 billion, $418 million and $344 million at September 30, 2015, respectively.

The Corporation revised certain MSR valuation assumptions during the three months ended September 30, 2016, resulting in a net $282 million increase in fair value, which is included within “Changes in fair value due to changes in inputs and assumptions” in the table above. The increase was primarily driven by changes in prepayment assumptions based on recent observed differences between modeled and actual prepayment behavior, which had the impact of slowing the weighted-average rate of projected prepayments, thus increasing both the weighted-average life of the MSRs and the yield that a market participant would require to buy the MSR.

The Corporation primarily uses an option-adjusted spread (OAS) valuation approach, which factors in prepayment risk to determine the fair value of MSRs. This approach consists of projecting servicing cash flows under multiple interest rate scenarios and discounting these cash flows using risk-adjusted discount rates. Weighted-average OAS levels for MSRs associated with fixed and adjustable-rate loans were 9.90 percent and 12.29 percent at September 30, 2016 and 4.62 percent and 7.61 percent at December 31, 2015.

Weighted-average lives of the MSRs associated with fixed and adjustable-rate loans were 4.70 years and 3.44 years at September 30, 2016 and 4.46 years and 3.43 years at December 31, 2015. The weighted-average life is not an input in the valuation model, but is a product of changes in both market rates of interest and model and other cash flow assumptions. The weighted-average life represents the average period of time that the MSRs' cash flows are expected to be received. Absent other changes, an increase (decrease) to the weighted-average life would generally result in an increase (decrease) in the fair value of the MSRs.

The weighted-average lives and fair value of MSRs are sensitive to changes in modeled assumptions. For example, a 10 percent or 20 percent decrease in prepayment rates could result in an increase in fair value of $125 million or $262 million, while a 10 percent or 20 percent increase in prepayment rates could result in a decrease in fair value of $113 million or $217 million. A 100 basis points (bps) or 200 bps decrease in OAS levels could result in an increase in fair value of $80 million or $167 million, while a 100 bps or 200 bps increase in OAS levels could result in a decrease in fair value of $75 million or $145 million. These sensitivities are hypothetical and actual amounts may vary materially. As the amounts indicate, changes in fair value based on variations 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, the effect of a variation in a particular assumption on the fair value of MSRs that continue to be held by the Corporation is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. In addition, these sensitivities do not reflect any hedge strategies that may be undertaken to mitigate such risk.