Countrywide Credit Industries on Wednesday reported a 14% increase in earnings for its third fiscal quarter as loan production set a record.

Investors, however, had expected a stronger performance and Countrywide's shares took a beating on the Big Board, dropping more than $3 to a 12-month low before recovering slightly.

According to David Loeb, chairman of the Pasadena, Calif.-based company, Countrywide got caught in a timing mismatch between prepayments in its mortgage servicing portfolio and a spike in interest rates.

Prepayments in the portfolio were running high in the second quarter, but many of them did not hit the company's books until the third quarter.

But the abrupt rise in interest rates in the third quarter reduced the gains the company has been racking up from its long position in options on Treasuries, which it uses to cushion the impact of runoff from its servicing portfolio.

"The servicing hedge worked quite well at a time of major change downward in interest rates and a wave of refinancings," Mr. Loeb said. "Now that wave of refis appears to have abated."

In its third-quarter report, Countrywide said its proceeds from hedging, which it uses to offset amortization charges, amounted to $10 million. The company had a hedging gain of $44 million in the second quarter and about $26 million in the first quarter. The company's fiscal year ends Feb. 28.

Protected Against Rate Drop

Mr. Loeb said Countrywide was continuing to hedge against both small and large declines in interest rates, which could restimulate the boom in refinancings. He added that he does not necessarily expect new declines in rates but wants to protect the company's giant servicing portfolio -- about $76 billion -- against any eventuality.

He added that continued high production was reducing the portfolio's weighted average coupon, making it less vulnerable to refinancings.

"Countrywide will continue to emphasize improving its share of the purchase mortgage market and remains committed to keeping its loan origination infrastructure in line with production activity," he said.

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