Reserves Will Offset Hedge Losses When Rates Rise.

In what seems like an eternal refinancing wave, it may be premature to worry about what happens when interest rates start to rise. After all, in the first week of this year, the average rate on fixed-rate, 30-year mortgage loans fell to 5.85%, a low not seen since the early 1960s.

But we all know that rates will one day rise again. And according to analysts at Merrill Lynch, accounting changes for the treatment of mortgage servicing rights may actually help lenders when that happens.

Of course, while rising rates will depress loan origination, lenders stand to benefit from rising MSR values when rates go up. Even more so now than during previous refinancing booms, according to Merrill Lynch's San Francisco- based mortgage finance analysts William Roy and Michael Hughes.

In a recent report, the analysts note that most of the industry's largest mortgage servicers have aggressively written down the value of their MSR assets by creating impairment reserves against those assets to reflect the impact of lower interest rates.

"These impairment reserves did not exist in the previous down cycle and will serve to offset hedge losses as interest rates rise during the next downturn," their report says.

Consolidation, leading to fewer competitors in the marketplace and fewer vicious price wars to compete for dwindling loan origination volume, and the new impairment reserves are among the most significant changes in the mortgage industry that have taken shape during the past few years. Both changes stand to benefit the industry, according to Merrill Lynch.

Moreover, they expect the nation's mega-servicers to lobby the secondary market agencies for lower capitalization requirements for holding MSRs. ...