More Tough Sledding on Rate Risk

You can't fault Washington Mutual for keeping investors and analysts in the dark. These may be trying times for the company, with its heavy exposure to home loan and consumer credit weakness, but the company continues to put out perhaps the most detailed quarterly financial reports in the industry. And while today's market is focused heavily on WaMu's ability to manage its credit risk exposure, the company also has to worry about interest rate risk.

WaMu may have bigger challenges on its plate than hedging its still considerable portfolio of mortgage servicing rights today, but the second quarter showed that MSR risk management is still a concern. WaMu's chief financial officer, Tom Casey, told investors during a conference call that WaMu lost $109 million during the quarter from the sale and servicing of home loans, but most of that loss related to lower gain-on-sale revenue as the company closed wholesale loan production and scaled back retail home loan production. WaMu also cited an increase in "repurchase reserves" related to prime mortgage loans, noting that the company has seen an increase in repurchase requests from investors.

The MSR portfolio saw lower revenue because it did not benefit from valuation adjustments related to slowing prepayment speeds, as it did in the first quarter.

"However, we are seeing slower prepayments in July, so we will watch that trend carefully and may see valuation adjustments in the third quarter," Mr. Casey said.

But while interest rate conditions may result in choppy MSR performance, one of the few bright spots for WaMu is an increase in its net interest margin on loans held by the bank. Mr. Casey said the company's net interest margin expanded strongly in the first half of the year, but that WaMu executives expect the NIM to expand "at a slower pace" during the second half of the year. WaMu's NIM increased by 19 basis points in the first quarter and 17 basis points in the second. The higher NIM helped WaMu offset shrinkage in its balance sheet as the company scaled back its home loan exposure.

Lenders have been lucky that so far, interest rate risk management has not suffered the sort of volatility that induces heartburn each quarter the way it sometimes has in credit crisis of the past. These days, it's the people responsible for credit risk management who are spending more time on the hot seat in executive boardrooms. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/