Third-Quarter Prepays Reignite Impairment: It's not the accounting rules that vex them but rather the 'convexity' of the mortgage servicing asset itself.

Not everyone has to worry about accounting for impairment anymore, but some lenders have chosen to stay with the traditional treatment of mortgage servicing rights in their quarterly financial statements. And for them, the third quarter is likely to include some negative surprises.

Mortgage rates ended the quarter lower than they started. According to Freddie Mac, the average contract rate on 30-year, fixed-rate mortgages was 6.78% on June 29. On Sept. 28, the average rate was 6.31%.

That 46 basis point decline in mortgage rates has revved up the refinancing engine again. Though refinancing activity hasn't shot up to refi boom proportions, there has been a notable increase in refinancing, according to the weekly mortgage application survey conducted by the Mortgage Bankers Association. At the end of the quarter, refinancing was running at about 45% of loan applications, up from the mid-30s earlier in the quarter.

So it's not surprising that early earning reports from the banking industry reveal some impairment damage. M&T Bank Corp., Buffalo, N.Y., said that it suffered a $5 million impairment to the value of its mortgage servicing rights. M&T Mortgage of Buffalo NY, ranked 37th among servicers at mid-year with $18.4 billion in servicing on its books, a 13% gain from mid-year 2005.

One year earlier, in the third quarter of 2005, M&T benefited from a $6 million reversal of impairment that raised the value of the MSRs.

This year's drop in MSR values didn't stop M&T from posting a 13% increase in its earnings per share for the quarter, but much of the company's earnings momentum seems to have come from an acquisition of branches from Citibank and from cost cutting measures.

As this edition of Mortgage Servicing ...