Just when you thought the financial crisis was in the rearview mirror, a final aftershock is about to hit the nation's third largest bank by assets. According to Citigroup's (NYSE:C) recent annual filing, nearly $19 billion of potentionally toxic home equity lines of credit, or HELOCs, dating back to the housing bubble will soon begin coming due.
The lurking threat stems from the way HELOCs operate. In the lead-up to the financial crisis, banks like Citigroup extended lines of credit to homeowners that allowed for amounts to be drawn for a period of time during which only interest was due. At the end of the draw period, the outstanding amount converted to an amortizing loan and principal started to come due as well.
This is where Citigroup finds itself today. Prior to June 2010, its HELOCs typically had a 10-year draw period. Do the math and it's obvious that the most toxic of these from 2005 to 2007 are about to begin amortizing. As of the end of last year, only 6% of Citigroup's revolving HELOCs had commenced amortization versus 72% which will reset between now and 2017.
Now, to be clear, Citigroup isn't going to lose all of this money. The largest chunk of these relates to borrowers with above average credit scores and considerable equity in their homes. These people will presumably be less inclined to default on their obligations and, in the event they do, Citigroup's losses will be at least partially cured by selling the collateral.
But beyond this group there's little question that many borrowers will find the added burden unmanageable. According to Citigroup's own estimates, the monthly loan payment for revolving HELOCs that reset between 2015 and 2017 could increase by an average of $360, or 170%. Additionally, as the bank warns, "increases in interest rates could further increase these payments given the variable nature of the interest rates on these loans post-reset."
This wouldn't be a problem if the economy had fully recovered. But as we know too well, it still has a long way to go. As Federal Reserve Chairwoman Janet Yellen pointed out earlier this week, in addition to a still-elevated unemployment rate, an estimated 7 million people are working part time but would like a full-time job, and an "extraordinarily large share" of the unemployed population has been out of work for six months or more.
Taking all of this into consideration, as well as Citigroup's considerable progress in other areas of its operations over the last few years, the takeaway for investors isn't black and white. Namely, while there's every reason to believe that Citigroup will continue heading in the right direction, the speed at which it does so will be throttled over the next few years as the bank works through elevated loan losses from its HELOC portfolio.