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. The securities issued through these transactions are guaranteed by the corresponding agency and, as such, under seller/service agreements the Corporation is required to service the loans in accordance with the agencies’ servicing guidelines and standards. Substantially, all mortgage loans securitized by the Corporation in GNMA and FNMA securities have fixed rates and represent conforming loans. As seller, the Corporation has made certain representations and warranties with respect to the originally transferred loans and, in some instances, has sold loans with credit recourse to a government-sponsored entity, namely FNMA. Refer to Note 19 to the consolidated financial statements for a description of such arrangements.

During the quarter ended June 30, 2011, the Corporation obtained as proceeds $270 million of assets as result of securitization transactions with FNMA and GNMA, consisting of $265 million in mortgage-backed securities and $5 million in servicing rights. During the six months ended June 30, 2011, the Corporation obtained as proceeds $ 605 million of assets as result of securitization transactions with FNMA and GNMA, consisting of $ 594 million in mortgage-backed securities and $ 11 million in servicing rights. During the quarter ended June 30, 2010, the Corporation obtained as proceeds $ 210 million of assets as result of securitization transactions with FNMA and GNMA, consisting of $ 206 million in mortgage-backed securities and $ 4 million in servicing rights. During the six months ended June 30, 2010, the Corporation obtained as proceeds $ 419 million of assets as result of securitization transactions with FNMA and GNMA, consisting of $ 411 million in mortgage-backed securities and $ 8 million in servicing rights. No liabilities were incurred as a result of these transfers during the quarters and six months ended June 30, 2011 and 2010 because they did not contain any credit recourse arrangements. The Corporation recorded a net gain $4.1 million and $5.0 million, respectively, during the quarters ended June 30, 2011 and 2010 related to these residential mortgage loans securitized. The Corporation recorded a net gain $10.4 million and $10.3 million, respectively, during the six months ended June 30, 2011 and 2010 related to these 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 six months ended June 30, 2011 and 2010:


	Proceeds Obtained During the Quarter Ended June 30, 2011
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Trading account securities:
Mortgage-backed securities - GNMA		—	$	217,296		—	$	217,296
Mortgage-backed securities - FNMA		—		48,229		—		48,229

Total trading account securities		—	$	265,525		—	$	265,525

Mortgage servicing rights		—		—	$	4,890	$	4,890

Total		—	$	265,525	$	4,890	$	270,415


	Proceeds Obtained During the Six Months Ended June 30, 2011
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Trading account securities:
Mortgage-backed securities - GNMA		—	$	472,870		—	$	472,870
Mortgage-backed securities - FNMA		—		121,247		—		121,247

Total trading account securities		—	$	594,117		—	$	594,117

Mortgage servicing rights		—		—	$	10,839	$	10,839

Total		—	$	594,117	$	10,839	$	604,956


	Proceeds Obtained During the Quarter Ended June 30, 2010
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Trading account securities:
Mortgage-backed securities - GNMA		—	$	165,675	$	2,518	$	168,193
Mortgage-backed securities - FNMA		—		37,814		—		37,814

Total trading account securities		—	$	203,489	$	2,518	$	206,007

Mortgage servicing rights		—		—	$	3,794	$	3,794

Total		—	$	203,489	$	6,312	$	209,801


	Proceeds Obtained During the Six Months Ended June 30, 2010
(In thousands)	Level 1		Level 2		Level 3		Initial Fair Value
Assets
Investments securities available for sale:
Mortgage-backed securities - GNMA		—		—	$	2,810	$	2,810
Mortgage-backed securities - FNMA		—		—		—		—

Total investment securities available-for-sale		—		—	$	2,810	$	2,810

Trading account securities:
Mortgage-backed securities - GNMA		—	$	327,600	$	4,147	$	331,747
Mortgage-backed securities - FNMA		—		76,506		—		76,506

Total trading account securities		—	$	404,106	$	4,147	$	408,253

Mortgage servicing rights		—		—	$	7,535	$	7,535

Total		—	$	404,106	$	14,492	$	418,598

During the six months ended June 30, 2011, the Corporation retained servicing rights on whole loan sales involving approximately $53 million in principal balance outstanding (June 30, 2010 - $41 million), with realized gains of approximately $1.1 million (June 30, 2010 - gains of $0.8 million). All loan sales performed during the six months ended June 30, 2011 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.

Classes of mortgage servicing rights were determined based on the different markets or types of assets being serviced. The Corporation recognizes the servicing rights of its banking subsidiaries that are related to residential mortgage loans as a class of servicing rights. These mortgage servicing rights (“MSRs”) are measured at fair value. Fair value determination is performed on a subsidiary basis, with assumptions varying in accordance with the types of assets or markets served.

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 six months ended June 30, 2011 and 2010.


Residential MSRs
(In thousands)	June 30, 2011			June 30, 2010
Fair value at beginning of period	$	166,907		$	169,747
Purchases		860			4,015
Servicing from securitizations or asset transfers		11,292			7,809
Changes due to payments on loans [1]		(8,397	)		(7,932	)
Changes in fair value due to changes in valuation model inputs or assumptions		(7,852	)		(1,645	)
Other disposals		(191	)		—

Fair value at end of period	$	162,619		$	171,994

[1]

Represents the change in the market value of the MSR asset principally due to the impact of portfolio principal runoff during the period. It is computed as the sum of the monthly loan principal collections, curtailments, cancellations and repurchases multiplied by the MSR fair value percentage. A reduction in the loan portfolio balance causes a reduction in the contractual servicing fees for future periods.

Residential mortgage loans serviced for others were $17.4 billion at June 30, 2011 (December 31, 2010 - $18.4 billion; June 30, 2010 - $17.9 billion).

Net mortgage servicing fees, a component of other service fees in the consolidated statements of operations, include the changes from period to period in the fair value of the MSRs, which may result from changes in the valuation model inputs or assumptions (principally reflecting changes in discount rates and prepayment speed assumptions) and other changes, including changes due to collection / realization of expected cash flows. Mortgage servicing fees, excluding fair value adjustments, for the quarter and six months ended June 30, 2011 amounted to $12.4 million and $24.8 million, respectively (June 30, 2010 - $11.9 million and $23.8 million, respectively). The banking subsidiaries receive servicing fees based on a percentage of the outstanding loan balance. At June 30, 2011, those weighted average mortgage servicing fees were 0.26% (June 30, 2010 – 0.27%). 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 retained at the date of the residential mortgage loan securitizations and whole loan sales by the banking subsidiaries during the quarter ended June 30, 2011 and the year ended December 31, 2010 were as follows:


	June 30, 2011			December 31, 2010
Prepayment speed		4.9	%		5.9	%
Weighted average life		20.3 years			17.1 years
Discount rate (annual rate)		11.5	%		11.4	%

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 the sensitivity to immediate changes in those assumptions at June 30, 2011 and December 31, 2010 were as follows:

Originated MSRs


(In thousands)	June 30, 2011			December 31, 2010
Fair value of retained interests	$	102,427		$	101,675
Weighted average life		11.7 years			12.5 years
Weighted average prepayment speed (annual rate)		8.6	%		8.0	%
Impact on fair value of 10% adverse change	$	(3,671	)	$	(3,413	)
Impact on fair value of 20% adverse change	$	(7,113	)	$	(6,651	)
Weighted average discount rate (annual rate)		12.6	%		12.8	%
Impact on fair value of 10% adverse change	$	(4,541	)	$	(4,479	)
Impact on fair value of 20% adverse change	$	(8,690	)	$	(8,605	)

The banking subsidiaries also own servicing rights purchased from other financial institutions. The fair value of purchased MSRs, their related valuation assumptions and the sensitivity to immediate changes in those assumptions at June 30, 2011 and December 31, 2010 were as follows:

Purchased MSRs


(In thousands)	June 30, 2011			December 31, 2010
Fair value of retained interests	$	60,192		$	65,232
Weighted average life		11.7 years			12.7 years
Weighted average prepayment speed (annual rate)		8.6	%		7.9	%
Impact on fair value of 10% adverse change	$	(2,502	)	$	(1,963	)
Impact on fair value of 20% adverse change	$	(4,417	)	$	(3,956	)
Weighted average discount rate (annual rate)		11.5	%		11.5	%
Impact on fair value of 10% adverse change	$	(2,789	)	$	(2,353	)
Impact on fair value of 20% adverse change	$	(4,935	)	$	(4,671	)

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 June 30, 2011 the Corporation serviced $3.7 billion (December 31, 2010 - $4.0 billion; June 30, 2010 - $4.2 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 June 30, 2011 the Corporation had recorded $156 million in mortgage loans on its financial statements related to this buy-back option program (December 31, 2010 - $168 million; June 30, 2010 - $141 million). During the six months ended June 30, 2011 and 2010, the Corporation did not exercise its option to repurchase delinquency loans that meet the criteria indicated above. 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.