Big banks are in the soup again for home loans made during the freewheeling years right before the financial crisis. This time, though, the ghosts returning to haunt Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM), and Wells Fargo (NYSE:WFC) are not those of first-lien, purchase mortgages, but home equity lines of credit.
Billions of dollars' worth of these loans -- dubbed Helocs -- will turn 10 years old very soon, ballooning borrowers' payments and putting the loans in danger of default. This could turn into a big headache for Bank of America, which holds a larger share of these loans hitting that benchmark date than its peers.
Legacy Helocs could cause trouble
Home equity lines of credit were hot during the run-up to the financial crisis, when banks would often lend in excess of 100% of a home's value. In 2007, banks racked up $310 billion in Helocs, the biggest one-year tally. Plummeting home values during the crisis put an end to the Heloc party, and lending activity fell. Banks are once again offering these loans, however, as property values begin to recover -- though they are more cautious these days.
But those old loans are beginning to cause problems. As Helocs approach the 10-year mark, borrowers will soon be required to pay more than just the interest on the loan, as principal payments begin to kick in, as well. The "reset" value of these payments can be large, adding another $500 to $600 to each monthly payment. Already, borrowers with Helocs taken out in 2003 are beginning to miss their payments, prompting officials from Equifax to forecast a "wave of disaster" over the next few years for the banks holding these loans.
Not as secure as once thought
Banks have often thought of these loans as relatively secure, since they were backed by borrowers' homes, and delinquencies were usually low. The mortgage meltdown has changed that thinking, and banks now face losses on $221 billion in Helocs between 2014 and 2018.
Banks generally keep Helocs on their balance sheets, as payments fluctuate with interest rate changes, giving banks a hedge against rising rates. Since these loans are usually the second lien on a home, however, banks can face a complete loss if borrowers default.
Currently, banks are holding about $529 billion of Helocs, with Bank of America holding $81.4 billion, Wells Fargo nearly $80 billion, and JPMorgan Chase a little over $70 billion. According to Bank of America's latest 10Q filing, Helocs represent 85% of the bank's total home equity portfolio.
Helocs are heating up again
Banks seem to be responding to this possible threat to their balance sheets by ramping up Heloc lending again. Analysts estimate that the value of these loans will reach more than $90 billion for this year, and will climb to $97 billion in 2014.
Bank of America is right out front in Heloc origination, having increased home equity lending nearly 70% this year, compared to 2012. By the end of September, the bank had $4.4 billion of new Helocs on its books. While banks are being more careful this time around -- only loaning 85% of untapped equity, for example -- borrowers are taking out these loans for extravagant purposes, such as pricey home renovations. Once again, it seems, homeowners are treating their home equity like a piggy bank, and banks are happy to enable them.
Then, there's the issue of how much of those legacy Helocs will be coming due in the next few years. For Wells Fargo, about $30 billion will reset by 2017, and for JPMorgan, the amount is similar -- around $31 billion.
Bank of America, however, is looking at approximately $65 billion in resets during a similar time period. In addition, a higher percentage of Helocs created in 2006 were essentially subprime -- which means, very probably, that many were written by Countrywide back in the day and could be more apt to default. Once again, when it comes to cleaning up after trashy mortgages, Bank of America will likely be mopping up the biggest mess.