Outperformance Rules the Day Again.

With servicing costs rising along with delinquency and default rates, people in the industry may be looking for a silver lining. For some big lenders, it's been hedging "outperformance."

Outperformance is really just another way of saying that a lender's hedging strategy missed the mark because of changing economic conditions. The good news is that this time dislocation in the capital markets hasn't hurt servicers, it has indirectly helped them on the hedging front.

Countrywide has suffered through many more bad news headlines than good ones lately, so let's highlight its hedging performance for the first quarter of this year. Lower interest rates forced Countrywide to reduce the fair value of its mortgage servicing rights by a stunning $1.56 billion as of March 31. But the company simultaneously posted hedging gains of $1.66 billion. That $109 million in hedging outperformance was a welcome bright spot on the company's first-quarter earnings report, a quarter in which Countrywide suffered a net loss of $883 million. It's the second time in a row that hedging outperformance has helped Countrywide stanch some of its losses. In the fourth quarter of 2007, Countrywide posted a $451 million gain from valuation changes in the net value of MSRs, net of hedging. Then, as now, the MSR values declined but not as much as the value of hedging instruments rose.

At Washington Mutual, the situation was similar, with the net gain ...