MSR Risk Attracting Attention of Regulators, Rating Agencies.

Fitch Ratings recently placed Countrywide Financial Corp. on notice that it could see a downgrade on its debt rating because of concern about the valuation and durability of its mortgage servicing rights. And Fitch isn't the only organization paying more attention to MSRs these days. Other lending giants may come under scrutiny from federal banking regulators, which recently announced plans to devote increased scrutiny to MSRs held by subsidiaries of large depository institutions.

Fitch cited the "increasing risk of impairment" to Countrywide's servicing portfolio as the primary reason for its action, noting that all mortgage lenders face a potential hit to their mortgage servicing rights if rates fall.

But Fitch said the impairment risk is particularly high for those companies, such as Countrywide, with high levels of capitalized mortgage servicing rights as a percentage of equity and a heavy concentration in the mortgage business.

In addition, the Fitch statement said that Countrywide's MSR portfolio includes an increasing level of subprime loans, home equity lines of credit, jumbo mortgages and adjustable-rate mortgages "which we believe are far more difficult to model and hedge" than conventional mortgage products.

Fitch alleges that Countrywide's MSR values are generated using "aggressive" valuation assumptions, including cross-sell income and late-fee income. Countrywide vigorously denies that its assumptions are aggressive compared to other lenders.

"Given the changing dynamics of the mortgage banking industry, Fitch believes that the difficulty in hedging the volatility of MSRs will likely increase in the future," the rating agency said.

That's certainly a plausible statement, but it might have made more sense before the start of the current refinancing boom in 2001. Another plausible scenario is that the opposite may be true - that, given the low coupon rate on loans ...