Calm and Clear Skies?

After two years of record-breaking refinancing and portfolio churning, it looks like mortgage servicers are likely to get a break. Economists predict the economy will start to gain momentum next year, suggesting that interest rates will stabilize and gradually rise. That should mean that portfolio runoff will ease.

That's the general macro-economic forecast for 2003. But please remember, we could have said the exact same thing a year ago.

As 2001 came to a close, economists were predicting that the economy would pick up steam in the second half of this year and that rates would gradually edge upward. The consensus forecast was that mortgage loan origination volume would taper off from 2001's $2 trillion record. Most experts in the housing finance sector were expecting loan origination volume to total $1.4 trillion this year, with refinancing accounting for between 30% and 40% of the total. Moreover, they expected refinancing to be tilted toward the first half of this year before falling off.

2002 didn't turn out that way, of course. In fact, it looks like total lending volume will once again pass the $2 trillion threshold,

perhaps by a substantial margin (at least one economist projects lending volume will total an astounding $2.4 trillion this year). And once again, despite a strong home purchase market, it is refinancing activity that has generated the lion's share of the activity.

By and large, most lender's have handled the impairment to their mortgage servicing portfolios with aplomb. The

"natural hedge" of loan production has offset the writedowns to the servicing portfolio for many lenders. And financial hedging has played a key role as well. It seems that more and more lenders are heeding the advice of experts and using financial hedges to minimize the impact that a fall in interest rates may have on the market value of their MSR portfolios. The ones who don't are hearing from investors. One small bank's CEO was excoriated by an institutional investor during a recent conference call and urged to "move into the 21st century" rather than relying on loan origination alone to offset servicing losses when rates fall. It may be good advice.

In general, the industry deserves high marks for handling the unexpected decline in long-term interest rates this year. Let's not let our guard down.

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