By Peter Rudegeair
Nov 26 U.S. borrowers are increasingly missing
payments on home equity lines of credit they took out during the
housing bubble, a trend that could deal another blow to the
country's biggest banks.
The loans are a problem now because an increasing number are
hitting their 10-year anniversary, at which point borrowers
usually must start paying down the principal on the loans as
well as the interest they had been paying all along.
More than $221 billion of these loans at the largest banks
will hit this mark over the next four years, about 40 percent of
the home equity lines of credit now outstanding.
For a typical consumer, that shift can translate to their
monthly payment more than tripling, a particular burden for the
subprime borrowers that often took out these loans. And payments
will rise further when the Federal Reserve starts to hike rates,
because the loans usually carry floating interest rates.
The number of borrowers missing payments around the 10-year
point can double in their eleventh year, data from consumer
credit agency Equifax shows. When the loans go bad, banks can
lose an eye-popping 90 cents on the dollar, because a home
equity line of credit is usually the second mortgage a borrower
has. If the bank forecloses, most of the proceeds of the sale
pay off the main mortgage, leaving little for the home equity
There are scenarios where everything works out fine. For
example, if economic growth picks up, and home prices rise,
borrowers may be able to refinance their main mortgage and their
home equity lines of credit into a single new fixed-rate loan.
Some borrowers would also be able to repay their loans by
selling their homes into a strengthening market.
ONCE USED LIKE CREDIT CARDS
But some regulators, rating agencies, and analysts are
alarmed. The U.S. Office of the Comptroller of the Currency, a
regulator overseeing national banks, has been warning banks
about the risk of home equity lines since the spring of 2012. It
is pressing banks to quantify their risks and minimize them
At a conference last month in Washington, DC, Amy Crews
Cutts, the chief economist at consumer credit agency Equifax,
told mortgage bankers that an increase in tens of thousands of
homeowners' monthly payments on these home equity lines is a
pending "wave of disaster."
Banks marketed home equity lines of credit aggressively
before the housing bubble burst, and consumers were all too
happy to use these loans like a cheaper version of credit card
debt, paying for vacations and cars.
The big banks, including Bank of America Corp, Wells
Fargo & Co, Citigroup Inc, and JPMorgan Chase & Co
have more than $10 billion of these home equity lines of
credit on their books each, and in some cases much more than
How bad home equity lines of credit end up being for banks
will hinge on the percentage of loans that default. Analysts
struggle to forecast that number.
In the best case scenario, losses will edge higher from
current levels, and will be entirely manageable. But the worst
case scenario for some banks could be bad, eating deeply into
their earnings and potentially cutting into their equity levels
at a time when banks are under pressure to boost capital levels.
"We just don't know how close people are until they
ultimately do hit delinquencies," said Darrin Benhart, the
deputy comptroller for credit and market risk at the Office of
the Comptroller of the Currency. Banks can get some idea from
updated credit scores, but "it's difficult to ferret that risk
out," he said.
What is happening with home equity lines of credit
illustrates how the mortgage bubble that formed in the years
before the financial crisis is still hurting banks, even seven
years after it burst. By many measures the mortgage market has
yet to recover: The federal government still backs nine out of
every ten home loans, 4.6 million foreclosures have been
completed, and borrowers with excellent credit scores are still
being denied loans.
NO EASY WAY OUT
Banks have some options for reducing their losses. They can
encourage borrowers to sign up for a workout program if they
will not be able to make their payments. In some cases, they can
change the terms of the lines of credit to allow borrowers to
pay only interest on their loans for a longer period, or to take
longer to repay principal.
A Bank of America spokesman said in a statement that the
bank is reaching out to customers more than a year before they
have to start repaying principal on their loans, to explain
options for refinancing or modifying their loans.
But these measures will only help so much, said Crews Cutts.
"There's no easy out on this," she said.
Between the end of 2003 and the end of 2007, outstanding
debt on banks' home equity lines of credit jumped by 77 percent,
to $611.4 billion from $346.1 billion, according to FDIC data,
and while not every loan requires borrowers to start repaying
principal after ten years, most do. These loans were attractive
to banks during the housing boom, in part because lenders
thought they could rely on the collateral value of the home to
"These are very profitable at the beginning. People will
take out these lines and make the early payments that are due,"
said Anthony Sanders, a professor of real estate finance at
George Mason University who used to be a mortgage bond analyst
at Deutsche Bank.
But after 10 years, a consumer with a $30,000 home equity
line of credit and an initial interest rate of 3.25 percent
would see their required payment jumping to $293.16 from $81.25,
analysts from Fitch Ratings calculate.
That's why the loans are starting to look problematic: For
home equity lines of credit made in 2003, missed payments have
already started jumping.
Borrowers are delinquent on about 5.6 percent of loans made
in 2003 that have hit their 10-year mark, Equifax data show, a
figure that the agency estimates could rise to around 6 percent
this year. That's a big jump from 2012, when delinquencies for
loans from 2003 were closer to 3 percent.
This scenario will be increasingly common in the coming
years: in 2014, borrowers on $29 billion of these loans at the
biggest banks will see their monthly payment jump, followed by
$53 billion in 2015, $66 billion in 2016, and $73 billion in
The Federal Reserve could start raising rates as soon as
July 2015, interest-rate futures markets show, which would also
lift borrowers' monthly payments. The rising payments that
consumers face "is the single largest risk that impacts the home
equity book in Citi Holdings," Citigroup finance chief John
Gerspach said on an Oct. 16 conference call with analysts.
A high percentage of home equity lines of credit went to
people with bad credit to begin with - over 16 percent of the
home equity loans made in 2006, for example, went to people with
credit scores below 659, seen by many banks as the dividing line
between prime and subprime. In 2001, about 12 percent of home
equity borrowers were subprime.
Banks are still getting hit by other mortgage problems too,
most notably on the legal front. JPMorgan Chase & Co
last week agreed to a $13 billion settlement with the U.S.
government over charges it overstated the quality of home loans
it sold to investors.
TIP OF THE ICEBERG
Banks have differing exposure, and disclose varying levels
of information, making it difficult to figure which is most
exposed. The majority of home equity lines of credit are held by
the biggest banks, said the OCC's Benhart.
At Bank of America, around $8 billion in outstanding home
equity balances will reset before 2015 and another $57 billion
will reset afterwards but it is unclear which years will have
the highest number of resets. JPMorgan Chase said in an Oct.
regulatory filing that $9 billion will reset before 2015 and
after 2017 and another $22 billion will reset in the intervening
At Wells Fargo, $4.5 billion of home equity balances will
reset in 2014 and another $25.9 billion will reset between 2015
and 2017. At Citigroup, $1.3 billion in home equity lines of
credit will reset in 2014 and another $14.8 billion will reset
between 2015 and 2017.
Bank of America said that 9 percent of its outstanding home
equity lines of credit that have reset were not performing. That
kind of a figure would likely be manageable for big banks. But
if home equity delinquencies rise to subprime-mortgage-like
levels, it could spell trouble.
In terms of loan losses, "What we've seen so far is the tip
of the iceberg. It's relatively low in relation to what's
coming," Equifax's Crews Cuts said.