Rising Tide Lifts Servicers in 3rd Quarter.

With mortgage rates ending the third quarter about 35 basis points higher than at the beginning of the quarter, it's no secret that most mortgage lenders reported positive MSR results for the third quarter.

And because lenders had a large backlog of loan applications coming into the third quarter, many saw a double benefit in the quarter. Loan production income remained strong even as servicing income gained strength.

Countrywide Financial Corp. is a good example. The company, which earned about two-thirds of its quarterly profit from mortgage banking, managed to post solid results despite taking a substantial charge related to Hurricane Katrina.

But with big servicers like Countrywide hedging their MSR portfolios heavily, the ability of MSRs to act as a "natural hedge" against lost loan production volume may be diminishing. Countrywide recognized a recovery in the value of retained interests of about $854 million in the third quarter vs. an impairment charge of about $1.4 billion in the second quarter of 2005. But as analysts at CreditSights pointed out in a recent report, this recovery was "substantially offset" by hedge losses of about $837 million, leaving a gain of just about $16 million in the third quarter.

Still, a big servicing portfolio helps mitigate the volatility in loan production to some extent. Countrywide said that it earned a 10 basis point margin from loan servicing in the third quarter. Servicing fee revenue advanced 38% from a year earlier as a result of the $262 billion increase in the size of the servicing portfolio.

And loan servicing added $228 million of pretax earnings to Countrywide's income statement in the third quarter, a sharp improvement from the pretax ...