Second Quarter a Tough One for Servicers

The second quarter was a doozy for mortgage servicers. Just when you thought that the only mention of "impairment" in the future was going to be in the context of recaptured value, long-term interest rates took a dip, leaving lenders exposed to more downward pressure on the value of their mortgage servicing rights.

That's because 30-year mortgage rates ended the second quarter about 60 basis points below where they began the quarter. Ouch.

BB&T Corp., Winston-Salem, N.C., saw a decline in quarterly income for the second quarter, and a sharp drop in servicing values was part of the problem.

Revenue from mortgage banking operations totaled $12.4 million for the second quarter, down from $44.3 million in the second quarter of last year.

BB&T said the decline primarily reflected "fluctuations in the valuation allowance for mortgage servicing rights." In the second quarter of this year, BB&T's results include a net provision for MSR valuation, including hedging activities, of $9.1 million. In last year's second quarter, the bank recaptured $30.4 million of valuation.

But BB&T's results also highlighted a complication in the impairment picture that many lenders faced this time around. The "natural hedge" between loan production and loan servicing didn't hold up as strongly this year as it has in the past.

At BB&T, revenue from residential mortgage production activities declined $8.7 million compared to the same quarter last year because a larger percentage of loan originations were retained this year.

In other cases, increasingly stiff competition for loan origination volume also diminished mortgage banking revenue.

Part of the problem with accounting for MSR values, whether a company actively hedges its portfolio or not, is that MSR valuations are a snapshot taken on the last day of the quarter. In other words, higher rates in April and May probably meant that BB&T's average MSR value for the quarter was considerably higher than the value stated on its balance sheet at the end of the quarter.

Fifth Third Bancorp, a well-respected Cincinnati-based lender, also saw its results hemmed in by impairment in the second quarter. In Fifth Third's case, amortization and impairment shaved $37 million from the company's earnings.

The company's mortgage servicing asset, net of the valuation reserve, was $368 million at June 30. The bank serviced $24.5 billion of mortgage loans.

Those are just a couple of examples of lenders that got caught in the impairment net this time around. There were many more, of course.

But every dark cloud has a silver lining, and this one is no exception. So far, the third quarter looks like its shaping up to be one in which lenders can recapture some of the value lost in the second quarter. And because loan pipelines were strong at the end of the second quarter, origination revenue should be strong as well. Of course, that sunny outlook all depends on where mortgage rates are on Sept. 30.

SNAPSHOT: BB&T Highlights 2Q '05 Impairment Problem

BB&T's MSR Valuation Problem

2nd Qtr'05 ($9.1MM)

2nd Qtr '04 $30.4 MM

Source: BB&T.

Note: parenthesis denotes a loss.

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