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Low Rates Raise Specter of MSR Impairment

As if mortgage servicers don't have enough to worry about heading into 2009, record low interest rates threaten to spur a new round of portfolio churning and servicing impairment.

At least, that's the risk lenders were facing as the industry began to tally fourth quarter and full year 2008 results. Credit woes aside, servicing rights all of a sudden no longer looked like such a great natural hedge to offset lower loan origination volume, given the peculiar factors placing stress on the economy. As MSN went to press, one small bank (Community Trust Bancorp of Pikesville, Ky.) warned investors to expect to see a decline in the market value of its MSR asset. The bank said its MSR write down will total about $1.1 million.

In the waning weeks of last year and in early January, the weekly home loan application survey of the Mortgage Bankers Association showed that refinancing activity was accounting for about 80% of home loan applications. That's even higher than the refi share during the peak months of the 2003 refinancing boom, perhaps the biggest wave of refinancing on record.

To be sure, one reason that the refi share was so high is that home purchase lending remained stubbornly low, reflecting lower home values and tightened underwriting guidelines that have made it difficult for many potential home buyers to take advantage of today's historically low interest rates. In the first week of January, the average 30-year mortgage rate averaged just 5.01%, the lowest ever recorded in the survey's nearly 40-year history of Freddie Mac's survey. That's about 20 basis points lower than at the low point of the refi boom, and it marked the tenth consecutive week of falling rates in the Freddie Mac survey. It was also the fourth week in a row that a new record low was established.

And get this - if you can afford the speedier amortization of a 15-year loan, your interest rate in early January averaged just 4.62%, according to Freddie Mac. That's almost half a percentage point lower than it was a year ago. No wonder those who have sufficient equity in their home and stable credit are rushing to refinance their loans.

But even with rates at historic lows, consumers are not rushing into the market, according to the MBA's weekly application survey. While home loan applications overall were up from a year earlier, they were down from the week before during the first week of January. On a four-week moving average, home purchase mortgage applications had edged up just a few percentage points despite the dramatic rate drop.

My guess is that over time, low mortgage rates will do more to stabilize and revise the housing sector than any proactive provisions being undertaken by the government to provide foreclosure relief.

And that will be good for the mortgage servicing industry. But the dramatic drop in interest rates certainly raises some accounting concerns for mortgage companies, as impairment of mortgage servicing rights could be added to the industry's list of woes.

During recent quarters, tightened underwriting slowed refinancing activity, helping to provide some portfolio stability for servicers. But with rates this low and origination constrained by weak consumer confidence and tight underwriting, there are plenty of originators out there focused on refinancing opportunity. On the bright side, refinancing should help save some borrowers with loan products that are making homeownership unaffordable. On the negative side, servicers will see higher prepayment rates than they had probably anticipated. In in a market as weird as today's, that's bound to pose some hedging challenges for the mortgage industry.

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