Another example of the complexity of big bank earnings, which make it difficult for an outsider to understand them.
The four biggest U.S. banks by assets may have to take writedowns on $55 billion of mortgage- collection contracts after marking them up by $11 billion in the second quarter, reports Bloomberg.
Bank of America Corp., JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. wrote up the value of the contracts, known as mortgage-servicing rights or MSRs, by 26 percent in the second quarter as mortgage rates climbed by about 0.35 percentage point. Net gains on the contracts added more than $1 billion to Wells Fargo’s record earnings in the quarter and $1 billion to JPMorgan’s first-quarter profit.
Mortgage rates fell about 0.26 percentage point in the third quarter, according to Freddie Mac, and servicing costs are rising, meaning the four banks, which handle collections on more than $5.9 trillion of U.S. mortgages, may face writedowns.
The value of the rights depends largely on the expected life of the mortgage, which ends when a borrower pays off the loan, refinances or defaults, reports Bloomberg. When rates drop and more borrowers refinance, MSR values decline. Banks typically hedge those movements using interest-rate swaps and other derivatives.
Under U.S. accounting rules in place since 1995, banks are supposed to report the value of their mortgage-servicing rights on a fair-market basis, or roughly what they would fetch in a sale. A bank must record a loss whenever it sells MSRs for a price below where they’re marked on the books.
Because there’s no active trading in the contracts, there are no reliable prices to gauge whether banks are valuing the rights accurately, analysts said.
“It’s an accounting game,” said Richard Bove, an analyst at Rochdale Securities Inc. in Lutz, Florida. “The deeper you get into the subject, the more items you find that are impossible to determine, and therefore it becomes a give up. Whatever they want to show, they show.”
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