Mixed Bag for Lenders

The third quarter produced a double whammy for some mortgage lenders. Falling rates pushed down mortgage servicing values. But with rates remaining higher than they have been for most of the time in recent years, there wasn't much loan origination ballast to offset the servicing losses.

Still, most lenders managed the pull through the third quarter with reasonably solid results, considering the circumstances.

Perhaps no company better illustrated the ins and outs of the mortgage servicing business in the third quarter than Wells Fargo. Wells is the nation's largest mortgage servicer.

But Wells Fargo Home Mortgage saw its revenue decline by $502 million to $923 million. Wells Fargo noted that in the third quarter of last year, the home loans group benefited from a $356 million recovery from an impairment reserve for the value of mortgage servicing rights. That wasn't the case this year.

Wells Fargo said that the reduction in the value of MSRs coupled with hedging gains resulted in a net loss of $86 million in the third quarter of 2006.

But Wells Fargo has good reason to stay in the mortgage servicing business. The company's servicing portfolio now generates about $1 billion in quarterly cash flow. In addition, Wells believes the mortgage portfolio is a key element of its cross-sales strategy to market additional products to existing customers.

The company said its owned mortgage servicing portfolio increased by 42 over the 12-month period. "Our owned real estate servicing portfolio grew to $1.33 trillion, up $215 billion for the quarter," said Mark Oman, senior executive vice president of the home and consumer finance group, in a company earnings release. "This growth included $172 billion of servicing acquired during the quarter. Our economies of skill and scale in servicing and our ability to cross sell and retain our servicing customers has made us a leader in a consolidating industry."

Much of that growth reflected the acquisition of servicing rights on $140 billion of loans from Washington Mutual. The company's home equity portfolio grew to $78 billion, up 9% from one year earlier.

Wells also touted its customer service initiatives and cross sales. In fact, Wells Fargo President and COO John Stumpf noted that Wells Fargo was the only mortgage lender to rank in the top five of both sales volume and service satisfaction in a recent customer satisfaction survey.

In a recorded call, Wells Fargo's chief financial officer, Howard Atkins, said that the home mortgage unit produced "relatively good results" given market conditions.

He said Wells Fargo achieved $947 million in gross servicing fees during the quarter, in line with the strong growth in the portfolio. That was 53% higher than a year earlier, Mr. Atkins said.

He said MSR management and hedging activities "continued to perform relatively well" given the decline in long-term interest rate and inversion of the yield curve at times.

He said Wells Fargo's MSR hedging results were "close to break even" results in the second quarter and resulted in only modest losses in the third. Wells said that as long term interest rates rose and the yield curve flattened earlier this year, Wells increased its hedging activities to protect the MSR asset.

Countrywide Financial Corporation, Wells' top competitor in the race to be the biggest mortgage servicer, also saw weaker mortgage banking results due to the challenging operating environment. Countrywide's mortgage segment contributed $424 million to pre-tax earnings in the third quarter.

Chairman and CEO Angelo Mozilo continues to see benefits from the company's strategy of balancing loan servicing and loan origination strengths. "However, consistent with the design of our macro hedge, we expect the loan production sector's fourth quarter results to benefit from increased refinance funding activity stemming from the third quarter decline in interest rates," Mr. Mozilo said.

Countrywide serviced a record $1.2 trillion in the third quarter, nearly tying the company with Wells Fargo as the largest servicers of home loans. But falling interest rates took a financial toll on the portfolio.

Countrywide said that net of hedges, the value of the mortgage servicing rights asset declined by $173 million in the third quarter.

Despite the drop in value, servicing remained operationally profitable. Countrywide said that its servicing fees, net of guarantee fees, totaled $941 million in the third quarter, not including miscellaneous fees, escrow balance income and income from retained interests. All told, Countrywide reported a $123 million earnings contribution from its mortgage servicing business despite the valuation allowance.

The delinquency rate also increased to 4.50%, compared to 4.03% at Sept. 30, 2004.

Washington Mutual, the nation's third largest mortgage servicer, also saw weakness in the mortgage unit during the third quarter.

WaMu's mortgage group lost $33 million in the third quarter, compared to a $302 million contribution in the third quarter of last year. The home loans group suffered from lower net interest margin as well as the other challenges, reflecting a decline in warehouse loan balances and a lower net interest margin.

A number of special factors also contributed to the decline in mortgage income, including a $31 million loss on its sale of servicing rights for $140 billion of mortgages to Wells Fargo. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com

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