Rise in Servicing Values Helps Offset Loan Sales Problem at WaMu

The chief executive of Washington Mutual Inc. said because of a mismatch between loan commitments and hedging, the company will take a loss during the quarter from the sale of mortgage loans. But some of the damage will be mitigated by servicing gains.

Kerry Killinger was speaking at the Lehman Brothers Financial Services Conference here.

He said that Seattle-based WaMu has a "balanced business model" so that the company will perform well in any interest rate environment.

During the refinance boom, the company had large gain on sale of loans with diminished asset growth and a reduced value of servicing rights. Now that rates have risen, that has turned around.

WaMu records the gain on sale of fixed-rate loans at the time the customer locks the interest rate.

During the presentation, Mr. Killinger, also president and chairman of WaMu, admitted that "several process and systems issues" at WaMu resulted in imprecision in its tracking of loan commitments. The spike in interest rates brought the problem out in the open as closing volumes increased.

As a result of these problems, WaMu will report a loss instead of a gain on sale. This loss will only be partially offset by the company's pipeline hedging activities.

On the other hand, because of the rising interest rates, WaMu has seen "a large recovery" in the value of its mortgage servicing rights and a reduction in MSR amortization. A substantial portion of the benefit of this, Mr. Killinger said, would be offset by a downward re-evaluation of its hedge, but the recovery of MSR value should offset the loss on the derivatives.

The rising interest rates will also lead to net growth in its servicing portfolio, he said.

The rise in rates has led to an increase in applications for adjustable-rate mortgages, up to 44% in August from 27% in June.

WaMu plans to retain the ARMs in its portfolio. To make room for these loans, he said, the company will be selling mortgage-backed securities and agency bonds for gains.

In the second quarter, WaMu had an efficiency ratio of 52.49%, above its long-term target, due to hiring temporary staff to handle the refinance boom. By using temporary staff, when the market turned, the company was able to adjust its cost structure, he said.

Mr. Killinger noted that WaMu has three options for capital deployment: share repurchases, expansion or grow its balance sheet. With the rise in interest rates, more of the company's capital will be used to grow the balance sheet through the retention of ARMs, although the company will also continue its share repurchase program.

In answer to a question, Mr. Killinger said WaMu only projects its earnings per share on an annual basis and it only does so as part of its quarterly earnings conference. He saw no reason at this point to deviate from that policy.

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