WaMu Plans to Rein in Size of MSR Asset

Capitalizing on its fourth consecutive quarter of profitable mortgage activities, Washington Mutual chairman and CEO Kerry Killinger last week told investors that his company is "positioned to go toe-to-toe with any competitor in the mortgage business."

At the same time, he said WaMu will try not to let its potentially volatile mortgage servicing rights asset grow beyond the company's ability to manage it.

WaMu reported that second-quarter net income climbed 73% to $844 million from the year earlier quarter, with home loans contributing almost half of that total.

Revenue from the sale and servicing of home mortgage loans, including MSR risk management, totaled $403 million in the second quarter of 2005, up from essentially zero in the second quarter of 2004.

The second-quarter mortgage results were weakened by $295 million in amortization and "risk management" costs associated with the MSR asset, WaMu executives noted in a conference call with investors and analysts.

But Mr. Killinger reiterated WaMu's plan to tighten the reins on MSR risk management, saying that WaMu intends to maintain the size of its MSR asset at about 25% of equity capital after the acquisition of Providian Financial, San Francisco. Because of the volatility of MSR values, he said WaMu's MSR value at any point in time might fluctuate between 15% and 35% of equity capital. WaMu valued its MSR portfolio at $5.74 billion as of June 30.

He said the 25% goal is the "right level" given the diversification of WaMu's businesses.

"We are not going down the direction of being a highly concentrated company," Mr. Killinger said.

But he said this limitation on MSR exposure does not necessarily mean that WaMu will have to halt the growth of its mortgage servicing portfolio. After a period of contraction, WaMu's MSR portfolio grew to $789 billion at June 30, up from $768 billion a year earlier.

Mr. Killinger said he expects WaMu's equity capitalization to grow over time, which would allow the MSR asset to grow on the balance sheet as well. He also suggested WaMu might seek ways to limit its MSR valuation, by reducing the servicing fee that has to be capitalized, for instance.

Mr. Killinger said future MSR growth would likely be "in line with the asset growth" of the company in general, but he left little doubt that servicing home loans is still a key part of WaMu's strategy for the future.

"We would love to grow our mortgage servicing business at the fastest rate we can go operationally and prudently," he said.

Mr. Killinger also weighed in on the housing bubble debate, saying that WaMu sees signs of "potential overextension" in some housing markets. He said WaMu is keeping an eye on house price trends and selling most of its riskiest home loans, such as option ARMs, into the secondary market.

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