Increases in discount rate reduce the value of our servicing rights due to the lower overall net present value of the cash flows.
In contrast, decreases in prepayment speeds, defaults and discount rates generally increase the value of servicing rights.
Refer to Note 13 to the Consolidated Financial Statements for the effect on the fair value of servicing rights carried at fair value for adverse changes to certain significant assumptions. Refer to the Servicing section within Business Segment Results for a discussion of the changes in servicing rights carried at fair value.
Interest Rate Lock Commitments
Fair values of IRLCs are derived using valuation models incorporating market pricing for instruments with similar characteristics and by estimating the fair value of the servicing rights expected to be recorded upon sale of the loan and are adjusted for anticipated loan funding probability. The loan funding probability ratio represents the aggregate likelihood that loans currently in a lock position will ultimately close, which is largely dependent on the loan processing stage that a loan is currently in, and changes in interest rates from the time of the rate lock through the time a loan is closed. The estimation process involved with the fair value of servicing rights is discussed above. Both the fair value of the servicing rights expected to be recorded upon sale of the loan and the loan funding probability ratio are based on management judgment; these inputs can have a material effect on the estimated fair values.
We have derivative instruments that we hold to manage the price risk associated with IRLCs and mortgage loans held for sale. These derivatives and mortgage loans held for sale are classified as Level 2 within the fair value hierarchy. Refer to Notes 7 and 8 to the Consolidated Financial Statements for additional information related to derivative instruments.
Allowance for Uncollectible Advances
We establish an allowance for uncollectible advances that provides for probable losses inherent in funded servicer and protective advances. The allowance is based on a collection risk analysis that considers the underlying loan, the type of advance, our customers’ servicing and advance reimbursement guidelines, reimbursement patterns and past loss experience. Although we examine a variety of available data to determine our allowance, our estimation process is subject to risks and uncertainties, including a reliance on historical loss and trend information that may not be representative of current conditions and indicative of future performance.
Asset Impairment Reviews
Goodwill is not amortized but rather is evaluated for impairment at least annually or more frequently if an event occurs that indicates goodwill may be impaired. We test for goodwill impairment at the reporting unit level, which is an operating segment or one level below an operating segment. The evaluation begins with a qualitative assessment to determine whether a quantitative impairment test is necessary. If, after assessing qualitative factors, we determine it is more likely than not that the fair value of a reporting unit is less than the carrying amount, then the quantitative goodwill impairment test is necessary.
The quantitative goodwill impairment test used to identify both the existence of impairment and the amount of impairment loss, compares the fair value of a reporting unit with its carrying amount, including goodwill. Fair value represents the price a market participant would be willing to pay in a potential sale of the reporting unit and is based on an income approach. If the fair value exceeds carrying value, then no goodwill impairment has occurred. If the carrying value of the reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
The determination of the fair value of a reporting unit requires us to make significant estimates and assumptions, including cash flows, growth rates and selecting appropriate discount rates. During the first quarter of 2018, we determined our Originations reporting unit was impaired and recorded an impairment charge of $9 million, which represents the entire amount of goodwill of the reporting unit.
Similar to goodwill, indefinite-lived intangibles, consisting of trade names, is not amortized and is tested for impairment at least annually or more frequently if an event occurs that indicates the asset may be impaired. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others, a significant decline in expected future results; a significant adverse change in legal factors or in the business climate; unanticipated competition; and slower growth rates. Any adverse change in these factors could have a significant impact on the recoverability of the trade names.