Rate Dip in March Puts Squeeze on 'Natural Hedge' Strategy.

With 30-year mortgage rates dipping to their lowest level since last July, the mortgage industry is likely to have another blockbuster year. But you might not know it from reading first quarter earnings reports.

That's because a recent boom in lending also means that impairment is rearing its ugly head again, threatening to blemish the balance sheets of mortgage servicers at the end of the first quarter. And the timing of the recent rate dip could obscure any offsetting benefit lenders receive from a surge of loan origination activity.

During the week of March 26, the average 30-year mortgage rate had risen slightly from 5.38% to 5.40%, but still was within roughly 20 basis points of the record lows seen last June. The 10-year Treasury rate, to which mortgage rates are closely tied, was about 50 basis points lower than at the end of last year.

Not surprisingly, refinancing has once again surged as a result, notes analyst Mike McMahon of Sandler O'Neill. Higher prepayment expectations will force lenders to reduce servicing valuations, he said in a recent report.

"Clearly, any entity with mortgage servicing rights on their books is going to be vulnerable at quarter-end to an impairment charge," Mr. McMahon told MSN.

The timing of the Treasury rally that has brought rates down means the mortgage industry will probably see more negative surprises than positive ones when companies start reporting first-quarter results, he said in late March. And those companies that "go naked," meaning they don't hedge their mortgage servicing rights, may leave investors feeling over-exposed to interest rate movements.

Companies that utilize a financial hedge will probably enjoy hedging gains that will likely offset much of the impairment. But ...