Navy Federal Credit Union 2015 Annual Report Download - page 68

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Financial Section 49
2015—SHARED SUCCESS
Mortgage Servicing Rights
MSRs are carried at fair value on a recurring basis. MSRs do not trade in an active, open market
with readily observable prices. Navy Federal obtains the fair value of its MSRs from a third-
party service organization, which determines fair value by discounting projected net servicing
cash flows of Navy Federal’s servicing portfolio, taking into consideration actual and expected
loan prepayment rate, discount rate, servicing costs and other economic factors. The fair value
of MSRs is primarily aected by changes in mortgage interest rates since rate changes cause
the loan prepayment acceleration factors to increase or decrease. The valuation is based on
unobservable inputs and therefore classified within Level 3 of the fair value hierarchy.
The key economic assumptions used in determining the fair value of MSRs at December 31, 2015
and 2014 were as follows:
2015 2014
Weighted-average life (years) 6.20 5.90
Prepayment rate 11.56% 12.63%
Yield-to-maturity discount rate 9.86% 9.84%
Derivative Assets and Liabilities
Fair values of Navy Federal’s interest rate swaps designated as cash flow and fair value hedges
are determined based on third-party models that calculate the net present value of future cash
flows discounted using the Overnight Indexed Swap (OIS) rate. Counterparty non-performance
risk is considered by discounting future cash flows using OIS rates adjusted for credit quality.
Navy Federal also uses an internal process to further evaluate the risk of counterparty default.
Fair values of Navy Federal’s IRLCs are determined based on an evaluation of best execution
forward contract prices sourced from the TBA market, adjusted by a factor that represents the
probability it will settle and become MLAS. IRLCs are classified as Level 3 in the fair value hierarchy.
Fair values of Navy Federal’s forward sales contracts on TBA securities are determined based on
an evaluation of best execution forward contract prices sourced from the TBA market, by agency.
As such, TBA hedges are classified as Level 2 in the fair value hierarchy.
Mortgage Loans Awaiting Sale
MLAS comprise those loans Navy Federal intends either to sell or to securitize. The initial
loan level basis is equal to unpaid principal balance plus or minus origination costs and fees.
Navy Federal has elected the fair value option for MLAS. The fair value of MLAS is determined
based on an evaluation of best execution forward sales contract prices sourced from the TBA
market, by agency (e.g., GNMA, FHLMC, FNMA). As such, MLAS are classified as Level 2 in the
fair value hierarchy.