Banks eye return of RMBS based on home equity loans

Wed Jun 11, 2014 3:31pm EDT

NEW YORK, June 11 (IFR) - Banks are mulling ways to securitize US home equity lines of credit - popular loans that suffered in the financial crisis but are coming back into vogue as house prices rise.

Lenders like the higher yields they can charge for the loans, known as HELOCs, but not the high capital provisions they require to satisfy Basel III rules.

So one option is to take the loans off balance sheet and bundle them into an RMBS - a common tactic before the crisis that created a US$100bn-plus HELOC securitization market back in the 2007 heyday.

While HELOCs dropped to cents on the dollar after the housing crash, loan volumes are now on the rise, driving hopes of a HELOC-backed RMBS comeback that could be spearheaded by lenders such as Wells Fargo, Bank of America, which acquired Countrywide, and JP Morgan Chase.

"For now, it's a balance sheet product going to high-net-worth individuals," a residential lender in the sector told IFR.

But the lender said would-be issuers are looking at how they can get to the securitization stage.

Getting investors on board is a major hurdle, especially as HELOCs suffered a 12-month loss severity rate of 86.78% as of June, according to data firm Intex.

Jonathan Kunkle, who heads LenderLive Network's document services arm, said originators are exploring securitization, but believes this time around issuers will need to retain some risk to make a HELOC-backed RMBS palatable to the buy side.

Kunkle is helping banks - and some non-depository lenders - dust off their home equity lending platforms to satisfy new consumer protection and regulatory rules.

UNDERWATER HOMES

Rating agencies have yet to receive inquiries from HELOC lenders about rating new HELOC-backed RMBS structures, but they will likely be cautious.

Critics say HELOCs lure borrowers into drawing out cash against their properties at low initial rates, which can leave them in a vulnerable position if rates rise to unsustainable levels.

Another problem is having enough loans to bundle together.

Some homeowners have been keen to take out a second line of credit against their homes as values have risen, resulting in US98.8bn of new lines opening in 2013 - a 26% year-on-year increase, according to Equifax.

But last year's origination volume was still only about a third of what it was in 2007.

It's often cheaper for homeowners to refinance a mortgage at record low rates than to add an extra loan, one banker said.

He said the sector is still largely focused on getting the first mortgage, prime jumbo RMBS market working.

Still, some market participants are hopeful of more HELOC growth ahead, and demand from borrowers whose home valuations are still under water is seen as a driving force.

There are 6.3m mortgaged US homes still stuck in negative equity territory as of the first quarter, according to report last week from CoreLogic.

Though that's an improvement from the 6.6m figure from the prior quarter, many people are still not in a position to refinance at current low rates or to make a profit by selling their homes.

"Based on what I see, people are staying where they are - spending money on their house," said Chris Gavin, a partner at Perkins Coie. "HELOCs make sense for a variety of people."

SHIFTING RISK

Even if investors can be won over, and loan volumes do balloon, banks are still mindful of the risks following high-profile failures of previous dominant players like Countrywide and billion dollar lawsuits that tarnished the sector's reputation.

Banks that opted not to securitize HELOCs, leaving them instead on their balance sheet, also suffered losses estimated at US$77bn since the financial crisis, according to Trepp data, mainly because little trickles down to this type of second lien if a borrower defaults on its first mortgage.

"If nothing is left over at foreclosure, it is a total loss," said Kunkle.

But the hope of offloading HELOCs from balance sheets is likely to prove too tempting eventually, especially as the average profit lenders make on first mortgages has steadily dropped.

The fourth quarter saw a new low of US$150 per loan per quarter, down from US$391 in the prior quarter, according to data from the Mortgage Bankers Association.

Meanwhile, efforts are under way to make this a safer product.

Wells Fargo in May said it would change its HELOC business by charging interest or a minimum payment each month that would pay down principal.

Another safeguard is that banks are now only making HELOC loans to customers they already know.

The strategy is expected to hold up better than pre-crisis practices, where third-party originators pushed as many borrowers as possible into HELOCs, regardless of whether that type of loan was suitable or not.

"There is zero correspondent HELOC lending going on now," Kunkle said. (Reporting by Joy Wiltermuth; Editing by Natalie Harrison and Marc Carnegie)