WaMu Revision Puts Focus on Basis Risk: By Ted Cornwell.(Washington Mutual)

A number of factors contributed to Washin-gton Mutual's recent announcement that it was reducing earnings guidance for this year, with an expected decline in mortgage origination volume playing a big role in the company's anticipation that mortgage banking revenue will decline.

But WaMu also said that its hedging of mortgage servicing rights also is a factor in the weaker outlook for mortgage banking, as MSN reported in our July edition.

The company's revision to earnings guidance sheds a little more light on the specific problem with hedging, and it's an issue that could affect other large lenders as well.

However, some stock analysts, including Jonathan Gray of Sanford C. Bernstein & Co., have said that WaMu's problem appears to be company specific rather than industrywide. In a research note following WaMu's reduced guidance, he argued that WaMu's servicing hedge is too large for its own good, swamping any benefit higher rates would provide the MSR value.

WaMu cited two concerns related to hedging in its June 28 announcement. First, the cost of hedging its mortgage servicing portfolio in a rising rate environment is going to rise, the company said.

Also, "significantly tightening basis spreads" mean that while the company's huge portfolio of MSRs rose in value during the second quarter, the company expected the losses it would take on hedging instruments to exceed the gains reported on the MSRs. In an ideal world, any lender would like to have the opposite happen.

The tighter basis spread between the mortgage and interest rate swap indices are behind the problem, WaMu said.