WaMu Evaluates Hedging Strategy

Washington Mutual's said its mortgage banking unit returned to profitability in the third quarter, largely because of better servicing performance than in the second quarter.

But even as the company benefited from its hedging of mortgage servicing rights, WaMu said it is working to reduce risk in its hedging strategy.

WaMu's MSR performance improved by $601 million from the second quarter due to lower medium-term interest rates and a widening of the spread between mortgage rates and the rates on certain financial instruments used to hedge the MSR risk. In the third quarter, WaMu posted a net MSR cost of $123 million, compared to a net MSR cost of $724 million in the second quarter.

Washington Mutual chairman and CEO Kerry Killinger said in a conference call with investors to discuss third quarter earnings that while the MSR "is a volatile asset," WaMu has been working with its hedging advisor to rely more on mortgage-related hedging instruments and less on interest rate swaps, a move that should reduce "basis risk" but may increase hedging costs.

Mr. Killinger said that WaMu continues to realign its mortgage banking business, consolidating loan servicing and loan production sites while beefing up its retail sales presence within WaMu's banking footprint.

"Our strategy is about more than just taking out cost. It's also about reinventing the way we do business in the mortgage banking segment," Mr. Killinger said. "We are paying closer attention than ever to the product mix.

"The goal is to assure that we are disciplined about originating higher margin product whenever we can."

The company's mortgage banking unit produced $271 million of net income in the third quarter, compared to a loss of $63 million in the second quarter. Improved mortgage servicing performance was a big part of that improvement, company executives said during a conference call.

Total lending volume fell to $61.8 billion in the third quarter, less than half the $131.9 billion in lending volume recorded in the third quarter of last year. Home-equity loan and line of credit volume rose 12% to $10.53 billion in the third quarter of this year. Adjustable-rate loans, including hybrids, accounted for 63% of WaMu's third-quarter mortgage banking loan volume.

While income was down from a year earlier, earnings increased from the second-quarter level, and Mr. Killinger said the company remains comfortable with its previously issued earnings guidance for the full year.

WaMu attributed the decrease from last year's third quarter to lower mortgage refinancing activity and lower gains from the sales of securities this year. However, better performance from mortgage servicing rights and related hedges fueled the improvement from the second quarter.

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