Magazine article American Banker

Will Hedges Come Back to Haunt Mortgage Firms?

Magazine article American Banker

Will Hedges Come Back to Haunt Mortgage Firms?

Article excerpt

Banks use a smorgasbord of instruments to hedge their mortgage businesses against interest rate movements -- a practice that has become increasingly important over the past three years as rates have dropped to historic lows.

But now that rates have started to rise rapidly, will those hedges become a problem?

In a report released Thursday, David Hendler, the head of financial services research at CreditSights Inc., wrote that hedging losses this quarter will add to the woes resulting from an expected decline in production volume caused by rising rates.

Mr. Hendler, who has warned throughout the year that too much of the record mortgage profits may be coming from hedging gains, now expects the trend to reverse in the third quarter.

After contributing to the sizzling mortgage earnings over the past year, hedging activities "will be probably the bane of the mortgage playing market" in the coming months, he wrote.

Gains in servicing portfolios would offset the losses, but they will come more slowly and could be limited by accounting rules, Mr. Hendler said in an interview Thursday. "We think this is going to place big pressure on third-quarter results."

He reiterated his "underweight" rating for the bank sector. In the interview, he cautioned investors to be wary of mortgage earnings. "This earnings stream is volatile; you shouldn't pay up for it."

The entire industry faces these problems, but judging from what he admitted was a limited amount of public information on their hedging activities, he said that Wells Fargo & Co., National City Corp. and J.P. Morgan Chase & Co. could suffer the most. However, he cautioned that his judgment on J.P. Morgan Chase was based on especially scant public disclosures.

In the report, Mr. Hendler also cited U.S. Bancorp as a company with worrisome hedges. However, "upon further conversations with U. …

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