Please ensure Javascript is enabled for purposes of website accessibility

The Financial Crisis' Final Hurrah Will Cost Bank of America Billions

By John Maxfield - Sep 30, 2015 at 10:18AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Bank of America and other leading banks have one final hurdle to clear before they can relegate the financial crisis to the dustbin of history.

The last vestiges of the financial crisis are set to make their way through bank balance sheets over the next two and a half years. The Office of the Comptroller of the Currency, one of the bank industry's primary regulators, issued a report earlier this year showing that $131 billion worth of home equity loans originated in the lead-up to the crisis start amortizing en masse at nine of the nation's biggest banks between 2015 and 2017.

You'd be excused for thinking this is old news. After all, most of the nation's largest banks have already charged off the vast majority of toxic loans originated before the crisis. In Bank of America's (BAC 3.10%) case, for instance, Chairman and CEO Brian Moynihan said at a conference this month that it has written off a total of $85 billion in crisis-related loans -- though a substantial portion of these were credit card loans.

The issue with home equity loans, however, is that they haven't yet had the opportunity to default. Let's say that you were approved for a $30,000 home equity line of credit in 2006. As soon as you started drawing from it, you'd be responsible for paying interest on the amount actually borrowed. But, importantly, even if you maxed out the credit line by borrowing all $30,000, you typically would not be obligated to begin paying down the principle until 2016, or 10 years later.

And herein lies the problem facing banks today. From 2005 to 2007, the nation's nine biggest home equity lenders originated $131 billion worth of home equity lines of credit, all of which come due between 2015 and 2017. According to the OCC:

While the $18 billion that [began amortizing] in 2014 provided these banks with a sense of the implementation issues, 2015 is the start of a three-year period when roughly $131 billion, or almost half of outstanding HELOC balances, have scheduled transitions from draw period to repayment. For most accounts, this transition means that monthly payments change from interest-only to amortizing, though a large number require full payment under a balloon note.

How big of a problem is this for any individual bank? While the answer to this is institution-specific, you can get a sense for it by looking at Bank of America's regulatory disclosures. Just under half of the loans in its home equity portfolio were originated in 2006 and 2007, at the worst possible time for the housing market. Of its home equity loans that have started amortizing, moreover, 14% of them are nonperforming. That's an enormous proportion when you consider that a bank like Wells Fargo seeks to limit its credit losses to less than 0.5% through all stages of the credit cycle.

The net result is that, at least in Bank of America's case, there's reason to believe that loan losses will be higher than normal for two more years. This will come as a disappointment to bank investors who have long since relegated the financial crisis to the dustbin of history, but it's nevertheless the case.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Bank of America Corporation Stock Quote
Bank of America Corporation
$35.89 (3.10%) $1.08

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/17/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.