Mortgage Servicer Role May Weigh on Banks

Just as banks are beginning to work the massive amount of bad debt through their systems, a less obvious creature related to the once-booming housing market may pose a threat as mortgage rates decline and homeowners refinance.

Mortgage-servicing rights, or MSRs, comprise a relatively small portion of the more than $1 trillion balance sheets of the major banks. Most of these banks also hedge against the risk of sharp movements in interest rates and against refinancing booms -- like the one going on right now. But smaller firms whose MSR portfolios comprise a bigger portion of assets are far more exposed to losses, especially those who consider hedging too costly.

For instance, National City, a mid-cap bank that was based in Cleveland, posted hundreds of millions of dollars in hedging losses on its MSR portfolio before regulators pushed it into the arms of PNC Financial Services (PNC Quote) at the end of 2008. First Horizon's (FHN Quote) First Tennessee Bank has sold off tens of billions of dollars' worth of MSRs to reduce its exposure to such assets. ...