WMC7 will record shows in H.264 if you are using the Hauppage HD-PVR. In my case, I am using the ATI DCT, so I am almost positive all of my recordings are MPEG-2. I have never had a problem converting WTV files to DVR-MS, unless the files were marked as copy protected.
Also, I have been recording episodes for particular series. All previous episodes have converted from WTV to DVR-MS without issue. The file size for a one hour show is 3.3GB. However, this week's episode is the one that won't convert.
Any other ideas?