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MSR Chiefs Still Challenged by Environment

Rising rates mean rising values for mortgage servicing rights, but the current shallow yield curve between long and short rates also has made hedging more difficult.

At the beginning of the second quarter, 30-year mortgage rates hovered around 6.35%, according to Freddie Mac's weekly survey of mortgage rates. At the end of the quarter, the 30-year FRM rate had risen to 6.78%, the highest level seen in more than four years.

And not many economists expect that flattening of the yield curve to dissipate anytime soon.

"Financial markets continue to expect more rate hikes by the Fed over the next six months, which has added upward pressure on mortgage rates," said Frank Nothaft, Freddie Mac vice president and chief economist, in a recent news release. Bad news perhaps for Realtors and mortgage originators, but perhaps welcome news to servicing executives. Mr. Nothaft and his economics team at Freddie Mac expect the 30-year FRM to remain below 7% through the end of this year, so they do not foresee a spike in long rates anytime soon.

But while impairment and amortization may not be concerns with regard to the MSR asset in the second quarter, current interest rate conditions are making it harder and more expensive to hedge the asset. With rates rising and the yield curve remaining shallow, hedging instruments have become more expensive for many lenders.

Last quarter, mortgage giant Washington Mutual warned that hedging MSRs was getting more expensive, and CFO Tom Casey warned that the MSR hedging challenge isn't expected to go away anytime soon.

At a recent investors conference, WaMu executives reiterated their expectation that the company's MSR results will be affected by a higher cost of hedging. The company also reiterated its intention to reduce the MSR asset as a percentage of capital by reducing mortgage servicing fees whenever possible.

And while second-quarter results were not yet released by most mortgage companies when this edition of MSN went to press, already there were indications that firms across the industry could see some hedging challenges.

Stock analysts at Merrill Lynch warned in a research report that First Horizon, a $94 billion mortgage servicer, would see a "modest recovery" in MSR hedge revenue for the second quarter, but not enough to bring the company back to year earlier levels. That, coupled with tight interest rate margins and loan sales margins, may squeeze mortgage profits for some firms in the industry.

While many expect home appreciation and sales activity to slow down, the news is not all bad. Fannie Mae chief economist David Berson said in a recent commentary that outstanding mortgage debt grew at a 12.5% annualized clip in the first quarter, though he expects MDO growth for the year to come in at 9.9%. Still, after at least four years of double-digit MDO growth, 9.9% sounds like pretty good growth for the market. (c) 2006 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com