Sales of Receivables and Servicing Rights

9 Months Ended

Sep. 30, 2017

Sales of Receivables and Servicing Rights

Sales of Receivables and Servicing Rights

12. Sales of Receivables and Servicing Rights

Residential Mortgage Loan Sales

The Bancorp sold fixed and adjustable-rate residential mortgage loans during the three and nine months ended September 30, 2017 and 2016. In those sales, the Bancorp obtained servicing responsibilities and provided certain standard representations and warranties, however the investors have no recourse to the Bancorp’s other assets for failure of debtors to pay when due. The Bancorp receives annual servicing fees based on a percentage of the outstanding balance. The Bancorp identifies classes of servicing assets based on financial asset type and interest rates.

Information related to residential mortgage loan sales and the Bancorp’s mortgage banking activity, which is included in mortgage banking net revenue in the Condensed Consolidated Statements of Income, is as follows:

		For the three months ended		For the nine months ended
		September 30,		September 30,
($ in millions)		2017	2016	2017	2016
Residential mortgage loan sales^(a)	$	1,593	1,846	4,740	4,591

Origination fees and gains on loan sales		40	61	106	156
Gross mortgage servicing fees		56	49	152	151

Represents the unpaid principal balance at the time of the sale.

Servicing Rights

Effective January 1, 2017, the Bancorp elected to prospectively adopt the fair value method for all classes of its residential mortgage servicing rights portfolio. Upon this election, all servicing rights are measured at fair value at each reporting date and changes in the fair value of servicing rights are reported in mortgage banking net revenue in the Condensed Consolidated Statements of Income in the period in which the changes occur. The election of the fair value method did not require a cumulative effect adjustment to retained earnings as there was no difference between the carrying value of the servicing rights, net of valuation allowance, and the fair value.

Prior to the election of the fair value method, servicing rights were initially recorded at fair value and subsequently amortized in proportion to, and over the period of, estimated net servicing revenue. Servicing rights were assessed for impairment monthly, based on fair value, with temporary impairment recognized through a valuation allowance.

The following tables present changes in the servicing rights related to residential mortgage and automobile loans for the nine months ended September 30:

($ in millions)		2017
Balance, beginning of period	$	744
Servicing rights originated - residential mortgage loans		99
Servicing rights acquired - residential mortgage loans		109
Changes in fair value:
Due to changes in inputs or assumptions^(a)		(15)
Other changes in fair value^(b)		(89)
Balance, end of period	$	848

Primarily reflects changes in prepayment speed and OAS spread assumptions which are updated based on market interest rates.
Primarily reflects changes due to collection of contractual cash flows and the passage of time.

($ in millions)		2016
Carrying amount before valuation allowance:
Balance, beginning of period	$	1,204
Servicing rights that result from the transfer of residential mortgage loans		55
Amortization		(96)
Balance, end of period	$	1,163
Valuation allowance for servicing rights:
Balance, beginning of period	$	(419)
Provision for MSR impairment		(125)
Balance, end of period		(544)
Carrying amount after valuation allowance	$	619

For the three and nine months ended September 30, 2016, temporary impairment, effected through a change in the MSR valuation allowance, was captured as a component of mortgage banking net revenue in the Condensed Consolidated Statements of Income. Amortization expense recognized on servicing rights for the three and nine months ended September 30, 2016 was $35 million and $96 million, respectively.

The Bancorp maintains a non-qualifying hedging strategy to manage a portion of the risk associated with changes in the value of the MSR portfolio. This strategy may include the purchase of free-standing derivatives and various available-for-sale and trading securities. The interest income, mark-to-market adjustments and gain or loss from sale activities associated with these portfolios are expected to economically hedge a portion of the change in value of the MSR portfolio caused by fluctuating OAS spreads, earnings rates and prepayment speeds. The fair value of the servicing asset is based on the present value of expected future cash flows.

The following table displays the beginning and ending fair value of the servicing rights for the nine months ended September 30:

($ in millions)		2017	2016
Fixed-rate residential mortgage loans:
Balance, beginning of period	$	722	757
Balance, end of period		831	597
Adjustable-rate residential mortgage loans:
Balance, beginning of period		22	27
Balance, end of period		17	22
Fixed-rate automobile loans:
Balance, beginning of period		-	1
Balance, end of period		-	-

The following table presents activity related to valuations of the MSR portfolio and the impact of the non-qualifying hedging strategy:

		For the three months ended		For the nine months ended
		September 30,		September 30,
($ in millions)		2017	2016	2017	2016
Securities gains, net - non-qualifying hedges on MSRs	$	2	-	4	-
Changes in fair value and settlement of free-standing derivatives purchased
to economically hedge the MSR portfolio^(a)		1	(16)	16	133
MSR fair value adjustment^(a)		(34)	-	(104)	-
(Provision for) recovery of MSR impairment^(a)		-	7	-	(125)

(a) Included in mortgage banking net revenue in the Condensed Consolidated Statements of Income.

The key economic assumptions used in measuring the interests in residential mortgage loans that continued to be held by the Bancorp at the date of sale or securitization resulting from transactions completed during the three months ended September 30, 2017 and 2016 were as follows:

		September 30, 2017				September 30, 2016
	Rate	Weighted-Average Life (in years)	Prepayment Speed(annual)		OAS Spread(bps)	Weighted-Average Life (in years)	Prepayment Speed(annual)		OAS Spread(bps)
Residential mortgage loans:
Servicing rights	Fixed	7.6	9.2	%	499	6.6	11.7	%	564
Servicing rights	Adjustable	2.5	35.1		650	2.8	30.0		681

Based on historical credit experience, expected credit losses for residential mortgage loan servicing rights have been deemed immaterial, as the Bancorp sold the majority of the underlying loans without recourse. At September 30, 2017 and December 31, 2016, the Bancorp serviced $60.8 billion and $53.6 billion, respectively, of residential mortgage loans for other investors. The value of MSRs that continue to be held by the Bancorp is subject to credit, prepayment and interest rate risks on the sold financial assets.

At September 30, 2017, the sensitivity of the current fair value of residual cash flows to immediate 10%, 20% and 50% adverse changes in prepayment speed assumptions and immediate 10% and 20% adverse changes in OAS spread are as follows:

					Prepayment						OAS
					Speed Assumption						Spread Assumption
			Fair	Weighted-Average Life				Impact of Adverse Change on Fair Value			OASSpread		Impact of Adverse Change on Fair Value
($ in millions)^(a)	Rate		Value	(in years)	Rate			10%	20%	50%	(bps)		10%	20%
Residential mortgage loans:
Servicing rights	Fixed	$	831	5.8	11.8	%	$	(37)	(72)	(161)	502	$	(16)	(32)
Servicing rights	Adjustable		17	3.3	25.2			(1)	(2)	(5)	784		-	(1)

(a) The impact of the weighted-average default rate on the current fair value of residual cash flows for all scenarios is immaterial.

These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on these variations in the assumptions typically cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. The Bancorp believes variations of these levels are reasonably possible; however, there is the potential that adverse changes in key assumptions could be even greater. Also, in the previous table, the effect of a variation in a particular assumption on the fair value of the interests that continue to be held by the Bancorp 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), which might magnify or counteract these sensitivities.