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Mixed Results for Risk Management

With interest rates rising during the second quarter (the average 30-year fixed-rate mortgage was about 50 basis points higher on June 30 than on March 31) you would think this might have been the best of times for the people who manage interest rate risk on mortgage servicing rights.

And for some, that was the case. At the end of the quarter, MSRs were more valuable than at the beginning of the quarter. But then again, some lenders found that turmoil in the capital markets, much of it related to subprime mortgage lending, had negative implications for the instruments used to hedge servicing portfolios.

On the positive side, a lot of companies shared the experience of BancorpSouth, which posted a $1.2 million increase in the fair value of its mortgage servicing rights during the second quarter. The bank also posted stronger loan origination activity.

That helped BancorpSouth post slightly higher net income in the second quarter of this year than last year. The company earned $35.9 million in the second quarter, up from $35.5 million in the same period of 2006. EPS was slightly lower due to an increase in shares relating to an acquisition during the past year.

But BancorpSouth didn't need the servicing rebound to make its mortgage results look good.

Chairman and CEO Aubrey Patterson said the company was "pleased with the growth of our mortgage lending business, which generated revenue growth of 33.8% for the quarter, excluding the impact of changes in the value of the mortgage servicing asset." He said the growth provides an opportunity to strengthen existing customer relationships and add new customers.

The news wasn't quite so good at Huntington Bancshares. Huntington said that it took a $4.8 million charge as a result of its hedging of mortgage servicing rights. In terms of net of hedging activity, Huntington still reported that its MSR asset lost $2 million when it was marked-to-market.

The MSR hedging hit was one of a number of charges, mostly related to loan losses and merger costs, that depressed Huntington's earnings.

Those other losses included a $24.8 million pre-tax loan loss provision expense related to loans in eastern Michigan and Ohio, both areas with weak economic conditions.

The company also booked $5.1 million of impairment losses on securities backed by subprime mortgage loans.

Like just about every other lender, Hungtington has tightened underwriting and reduced its reliance on brokers to generate loans. The company discontinued taking broker-originated home equity loans.

Huntington booked a $60.1 million provision for loan losses in the second quarter, up by $44.4 million from the year-ago quarter.

The valuation of mortgage servicing rights is a tricky issuer with many moving parts, including features of the portfolio and interest rates. There has been debate in the industry about whether or not some companies value their MSRs too highly. Others are sometimes accused of trimming the value of MSRs, hoping to recoup some value in a future weak quarter to smooth out earnings. While most of the valuation process is objective and often is supported by third party valuation experts, there is enough wiggle room within acceptable parameters so that different companies, making different economic assumptions, could reach different estimates about the value of the same MSR portfolio.

Hedging is a double-edged sword. Most big lenders rely on some combination of a "natural" hedge and economic hedging instruments to try to wring out some of the volatility in MSR values.

The second quarter was a tricky one. While some lenders posted gains in lending volume, most saw volume decline as a result of changing market conditions and tighter underwriting. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.bondbuyer.com/ http://www.sourcemedia.com/