Mortgage Servicing

Residential real estate mortgages are originated by the Company both for its portfolio and for sale into the secondary market. The transfer of these financial assets (i.e. loans) is accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (i) the assets have been isolated from the Company, (ii) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (ii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. The Company may sell its loans to institutional investors, such as Freddie Mac, and may do so on either on a servicing rights released basis or servicing rights retained basis. Should the Company enter into an agreement with the investor to retain or acquire the servicing rights, the Company will record a servicing asset (i.e. MSR). The Company will enter into an agreement with the investor to pay an agreed-upon rate on the loan, which is less than the interest rate received from the borrower. The Company will retain the difference as a fee for servicing the loan. The Company will capitalizes the MSR at fair value within other assets on the statements of condition upon sale of the related loan, and subsequently amortize the asset over the estimated life of the serviced loan and assesses quarterly the asset for impairment.

The balance of MSRs, net of a valuation allowance, included in other assets on the consolidated statements of condition at December 31, 2015 and 2014 was $2.2 million and $493,000, respectively. The increase in MSRs at December 31, 2015 over December 31, 2014 was primarily driven by acquired MSRs of $1.6 million in connection with the SBM acquisition.

In evaluating the reasonableness of the carrying values of the MSRs, the Company obtains third party valuations based on loan level data including note rate, type and term of the underlying loans. The model utilizes a variety of assumptions, the most significant of which are loan prepayment assumptions and the discount rate used to discount future cash flows. Prepayment assumptions, which are impacted by loan rates and terms, are calculated using a three-month moving average of weekly prepayment data published by the Public Securities Association and modeled against the serviced loan portfolio by the third party valuation specialist. The discount rate is the quarterly average 10-year U.S. Treasury rate plus a risk premium. At December 31, 2015 and 2014, the prepayment assumption used within the model was 11.0% and 11.7%, respectively, and the discount rate was 7.5% and 7.0%. The estimated effect of a 10% and 20% adverse change to the prepayment assumption at December 31, 2015 was a decrease of $79,000 and $238,000, respectively, while a 10% and 20% adverse change to the discount rate assumption was a decrease of $129,000 and $246,000. Other assumptions include delinquency rates, foreclosure rates, servicing cost inflation, and annual unit loan cost. All assumptions are adjusted periodically to reflect current circumstances.

Amortization of the mortgage servicing rights, as well as write-offs of capitalized rights due to prepayments of the related mortgage loans, are recorded as a charge against mortgage servicing fee income. Mortgage servicing fee income, net of amortization and write-offs, for the years ended December 31, 2015, 2014 and 2013 was $624,000, $251,000, and $679,000, respectively. Mortgage servicing fee income is presented in mortgage banking income, net on the consolidated statements of income. Also included within mortgage banking income, net on the consolidated statements of income is the net gains or losses recognized upon the sale of originated mortgage loans. For the years ended December 31, 2015, 2014 and 2013, the Company sold $61.2 million, $799,000, and $33.3 million, of residential mortgage loans on the secondary market, which resulted in a net gain on sale of loans of $1.3 million, $31,000, and $728,000, respectively. The increase in mortgage servicing fee income and gains on mortgage loan sales reflects the Company's strategic shift in 2015 to ramp up its mortgage banking business in order to reduce interest rate risk by selling its 30-year mortgage production and generating gains from the sales. With the acquisition of SBM on October 16, 2015, the Company gained the strength of SBM's established mortgage banking business, which included many seasoned mortgage loan officers spread across Southern Maine to Massachusetts.

The following summarizes MSRs capitalized and amortized, along with the activity in the related valuation allowance:



	As Of and For The Years Ended December 31,
	2015			2014			2013
MSRs:
Balance at beginning of year	$	493		$	726		$	542
Capitalized upon sale	294			15			466
Acquired in connection with SBM acquisition, at fair value	1,608			—			—
Amortization charged against mortgage servicing fee income	(231		)	(262		)	(340		)
Valuation adjustment	(3		)	14			58
Balance at end of year	$	2,161		$	493		$	726
Valuation Allowance:
Balance at beginning of year	$	(1	)	$	(15	)	$	(73	)
Increase in impairment reserve	(3		)	—			(34		)
Reduction of impairment reserve	—			14			92
Balance at end of year	$	(4	)	$	(1	)	$	(15	)
Fair value, beginning of year⁽¹⁾	$	1,447		$	1,494		$	879
Fair value, end of year⁽¹⁾	2,947			1,447			1,494


(1)	Reported fair value represents all MSRs currently being serviced by the Company, regardless of carrying amount.

Mortgage loans serviced for third party investors are not included as portfolio loans in the Company's consolidated statements of condition. Mortgage loans serviced for investors at December 31, 2015 and 2014 were $963.0 million and $733.0 million, respectively. Custodial escrow balances maintained in connection with the foregoing loan servicing for investors, and included in demand deposits, were $7.1 million and $8.2 million at December 31, 2015 and 2014, respectively.

While not capitalized as MSRs, the Company serves as the primary servicer of loans originated by MaineHousing. The Company has entered into a contract with MaineHousing to perform loan servicing on the MaineHousing portfolio for a fee. For the years ended December 31, 2015, 2014 and 2013, the Company earned fees of $1.2 million, $1.2 million, and $1.1 million, respectively, for the servicing of MaineHousing loans and is included in other income on the consolidated statements of income. The MaineHousing loans serviced by the Company, which are not included in the Company's portfolio loan balance within its consolidated statements of condition, totaled $612.1 million and $585.3 million at December 31, 2015 and 2014, respectively. Custodial escrow balances maintained in connection with the foregoing loan servicing for MaineHousing and included in demand deposits were $4.3 million and $5.3 million at December 31, 2015 and 2014, respectively.

In addition to fees earned for servicing the portfolios of investors, servicer guides impose certain time-lines for resolving delinquent loans through workout efforts or liquidation and impose compensatory fees on the Company if those deadlines are not satisfied other than for reasons beyond our control. The investors also have a contractual right to demand indemnification or loan repurchase for certain servicing breaches. For example, the Company would be required to indemnify the investors for or against failures by the Company to perform its servicing obligations or acts or omissions that involve willful malfeasance, bad faith or gross negligence in the performance of, or reckless disregard of, its duties. The Company records expenses for servicing-related claims and loan repurchases when it is probable that such claims or repurchases will be made and the amounts are reasonably estimable.