The Principal Lesson

Principal Financial Group, the parent of Des Moines-based Principal Residential Mortgage announced in December that a writedown of its mortgage servicing rights would reduce net income and operating earnings by upwards of $70 million. In and of itself, that would hardly be big news given current interest rate conditions. But for the first time, Principal said that its impairment charge will not be offset by loan production gains.

And that could be a problem for the industry as the refinancing boom slows down.

For the past several years, lenders have taken big hits from servicing amortization and impairment. But always, they could rely on loan production gains - part of the "natural hedge" - to offset the servicing losses. But what happens at the end of the biggest refinancing boom in history? With loan volume slowing down and the origination market becoming more competitive, lenders may find it more difficult to offset servicing losses.

Hopefully, the flow of mortgage servicing impairment charges will slow down as well. But with 30-year mortgage rates still below 6% as last year came to a close, it is likely that refinancing activity will continue to account for a big chunk of mortgage lending. And that means portfolio runoff remains an issue for mortgage servicers.

But at the same time, lending volume is expected to slow this year, and perhaps precipitously. Some economists believe total loan origination volume will decline by more than 50% from last year's record level. And that does not bode well for most mortgage companies.

Under normal circumstances, rising values for mortgage servicing rights would help to offset declines in loan production volume. But after three years of record loan volume and historically low interest rates, circumstances are anything but normal. It is possible that even if rates hover at current levels, loan production volume will fall off. But servicing values may not rise significantly in that scenario, and could even fall if rates slip downward. That could leave lenders facing a kind of worst-case scenario - falling loan production gains and lower servicing values at the same time.

Already there are signs of competitive pricing in the loan production business, an indication that lenders are fighting over a shrinking pie of loan origination business. Hopefully, the industry will enjoy a soft landing from the refi boom, but lenders should be prepared for some bumpy quarterly results along the way.

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