Three Writedowns; Three Records

For the nation's three largest mortgage servicers, the first quarter could have been a disaster.

With interest rates falling to record lows once again, the big servicers inevitably had to take hits to the value of their mortgage servicing rights. But for Washington Mutual, Countrywide and Wells Fargo, all's well that ends well.

All three reported record first-quarter income, with loan origination profits and financial hedges offsetting losses on the servicing side of the business.

Record mortgage volume translated into record income for Washington Mutual in the first quarter, with the company surpassing $1 billion in quarterly earnings for the first time.

WaMu also benefited from a rise in its net interest margin and successful hedging of its $728 billion mortgage servicing portfolio, which was subject to a $536 million impairment writedown in the quarter.

"We continued to be disciplined in our risk management and confident of our valuation methods," chief financial officer Tom Casey said on a conference call to discuss first-quarter results.

In addition, he said the average coupon rate on the servicing portfolio has declined to 6.66%, continuing a trend that will "lengthen the life of the portfolio and the customer relationship." Not to mention increasing the portfolio's value when rates rise.

WaMu sold $141 million excess mortgage servicing rights in the quarter, bringing total excess servicing sales since the second quarter of last year to $1.1 billion. Mr. Casey said the sale of excess servicing allows WaMu to reduce the amount of MSRs on its balance sheet while maintaining customer relationships.

Wells Fargo, the nation's second biggest servicer with MSRs on $580 billion of home loans (including subservicing), also dodged the bullet, reporting an exceptional first quarter.

Wells Fargo produced $103 billion of home loans in the quarter, down slightly from the fourth quarter, but still at a pace that suggests it could break single-company records this year.

Moreover, the company's mortgage servicing rights appear to be growing ever more valuable, even as the company writes down the value of its MSRs to reflect record-low interest rates. Over the past 12 months, Wells has reduced the value of its MSRs by $2.9 billion, including $351 million in the first quarter.

That took a bite out of gains made on the loan origination side of the business, according to chief financial officer Howard Atkins.

"A significant amount of origination and hedging-related revenue earned by the mortgage company in the first quarter was offset by the mortgage servicing rights amortization and the impairment provisioning," he said on a recorded call for investors.

But the MSR portfolio keeps growing, and Mr. Atkins said the company is well positioned to benefit from its MSRs in the future. The average note rate on the portfolio has declined 62 basis points over the past 12 months to 6.45% at the end of the first quarter.

Because of the low average note rate and reductions in the capitalized value as a percentage of the portfolio, "the incremental value of the servicing portfolio in a rising rate environment has increased from prior periods," Mr. Atkins said.

Wells Fargo has reduced the value of its residential and commercial MSRs by over $2.9 billion during the past 12 months to $4.2 billion at the end of the quarter.

The strength in mortgage banking showed up in Wells Fargo's income statement as well. Mortgage banking non- interest income totaled $561 million in the first quarter, a 56% improvement over last year's also strong first quarter.

In addition, Wells Fargo reported $814 million of interest income from mortgages held for sale, a 38% increase from the year-earlier period.

Those numbers contributed to Wells Fargo's record net income of $1.49 billion, up 8% from the first quarter of last year. Wells has reported seven consecutive quarters of record income.

Countrywide Financial Corp., the nation's third largest servicer with MSR's on $510 billion of home loans as of late April, also reported record earnings, despite losing $660 million of value on mortgage servicing rights and other retained interests to impairment. The company also reported amortization costs of $363 million, that bring the total loss in MSR value to about $1 billion for the quarter. (See related story, page 16)

Taking hedging and income earned from servicing into account, Countrywide reported that its servicing sector lost $554 million on a pretax basis in the first quarter.

But that didn't stop the mortgage banking unit from earning $354 million on a pretax basis, capitalizing on $882 million of earnings from the loan production sector.

In fact, despite cumulative servicing writedowns of more than $6 billion, Countrywide has achieved record earnings for eight consecutive quarters.

Chairman and CEO Angelo Mozilo said losses from the MSR value have done nothing to diminish his enthusiasm for loan servicing. In fact, the company continues to grow its portfolio at an impressive rate, eclipsing Chase Manhattan to become the nation's third largest mortgage servicer.

The loans in Countrywide's portfolio are on average just 18 months old and have a weighted-average coupon rate of 6.6%, he said during a presentation at a UBS Warburg investment conference.

Countrywide's portfolio is valued at 115 basis points of the dollar amount of loans in the portfolio. That's down from 221 basis points in February of 2000, but the market value will start rising again when rates rise.

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