The Banks' Next Hot Zone: Home Equity Delinquencies

Delinquencies on home equity loans and lines of credit are at their highest levels in a decade.
That should give Wall Street and investors pause. Because when home equity borrowers, default on their lines of credit, bankers don't have first recourse to the underlying property, the home. Mortgage bankers who own the mortgage on the home do. That's why bankers are growing ashen-white over looming losses, and why they are scrambling to fix this problem now.

The numbers are staggering. Borrowers had outstanding $1.12 tn of home equity loans this year, virtually the same amount in the fourth quarter of 2007.

The American Bankers Association recently said the percentage of home equity lines of credit more than 30 days past due rose to 1.10 % during the first quarter, the highest since 1997, though still lower than bank card delinquencies which hit 4.51 %, slightly above the five year average delinquency rate of 4.40 %. The number of home equity lines more than a month past due is 55% above the average since the American Bankers Association began tracking it around 1990; delinquencies on home equity loans are 45% higher.

Sluggish personal income growth, plunging home equity, job losses and a rocky stock market, as well as soaring food and energy prices, are partly to blame for the spike in delinquencies.

Over the past two decades, value of home equity loan balances outstanding soared to more than $1 tn from just $1 bn. One in four homeowners have a home equity line of credit, and banks have made huge sums of money on them due to fat fees, returns that are a quarter or 50% higher than regular consumer loans.

Lenders are to blame for recasting these loans as borrowings that really didn't seem to be backed by their most important investment, their homes, caling these loans "equity access" or as a Citigroup campaign called it, take a home equity loan and "Live Richly" or as Fleet Bank once advertised it, ""The smartest place to borrow? Your place." All glammed up ways to essentially hock your house.

Bank exposure to home equity lines/loans are a major problem is huge. At last look, Wells Fargo (WFC) had $84 bn of them on their portfolio. In late 2007, Wells Fargo hived off $12 bn in home-equity loans in a separate portfolio to prepare them for liquidation. Bank of America (BAC), Wachovia (WB) and JPMorgan Chase have frozen borrowers' access to home equity lines or changed the terms to cut their potential home equity exposure, The Financial Times reports.  

National City (NCC), the US bank that has been among the hardest hit by the subprime crisis, is trying to cut its exposure to the riskiest category of home loans by offering customers cash to close their untapped home equity lines, the Financial Times reported.

If the scheme is successful, analysts say other banks could follow suit, choosing to spend money now to avoid taking on more exposure to the US housing slump.

The bank's initiative, which was launched at the end of July, encourages National City customers to surrender their unused home equity lines by waiving the $350 fee it would normally charge for closing the line and by writing customers a $200 check. The idea here is to avoid future losses on lines or home equity loans that go belly up by enticing borrowers to bail out of them early with cash. The question for banks is, will this be a help in getting their own houses in order, and, for borrowers, is it worth taking the money and running?

Finally, the losses don't just stop on the loans and lines of credit themselves. They also will take a bite out of bonds backed by these borrowings.

Moody's Investors Service issued a report recently that said losses on prime home-equity loans, also called second mortgages, repackaged into bonds, vintage 2007, will climb to 17% on average. Home equity backed bonds from 2006 will rise to 13%, and 6% for 2005.

For home-equity lines of credit, 2007 bond losses will rise to 26 %, Moody's said. For 2006, losses on securities will increase to 24 %, while losses for 2005 "vintage" bonds will reach 9%.