Is Bank of America Behind the HELOC Risk Curve?

Posted on July 31st, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

Although this story is Bank of America-specific, most large banks such as Wells, Chase and CITI are running scared of their Home Equity Line/Loan exposure due to the sheer size of their portfolios, the high risk of default across all borrower grades and the low probability of recovery.

The Journal wrote a great piece on HELOC’s tonight specifically mentioning Wells Fargo, First Horizon and Fifth-Third:

Many (banks) who were caught flat-footed when these loans turned sour now assume that home-equity loan risk already is factored into bank stock prices, which have tumbled. But investors may be too upbeat once again. For one thing, the recent news isn’t exactly uplifting: 2.22% of all home-equity loans were charged off by banks in the second quarter, an all-time high. That is up from 1.69% in the first quarter and 0.9% in the fourth quarter of last year. Tax refunds and government-issued stimulus checks likely are at least partly responsible for why things aren’t worse.

Using this stance, investors should use caution when it comes to First Horizon National. According to a Goldman analysis, 15% of First Horizon’s home-equity loans, or 5% of all its loans, were made by outside parties. Outsider-written loans represented 22% of Fifth Third Bancorp’s portfolio, or 3% of its total loans. And 14% of Wells Fargo’s home loans, or 3% of total loans, were written by third parties.

These three banks also have a relatively high number of home-equity loans that are at least 90% of the value of the underlying houses, which is worrisome. Some investors also are concerned about E*Trade, which bought almost all of the home-equity loans on its book.

In addition, if you want a run down on the banks with the greatest Home Equity exposure, Fitch put out a great report a few months back entitled Big Bank’s Home Equity Woes.

HELOCs were widely kept by the banks and not securitized and sold like most first mortgages. In addition, most HELOCs are not secured by the property any longer because values dropping so much since the time the loans were originated. Most were originated between 2005-2007 and the average LTV was over 80% at the time of origination. Values are down 32% in CA in the past 12-months in CA for example, so you can see the problem. THEY CAN’T FORECLOSE! If they do, the first mortgage holder gets it all, leaving the second lien holder high and dry.

This following is anecdotal evidence, but worth noting.

A friend has a first mortgage at with a national big-name bank and Home Equity Line of Credit through BofA. He bought the home for $900k with 20% down ($720k loan) a year and a half ago. Shortly after the purchase he did a cash out refi for $840k then put a 95% $155k+ HELOC on the property using “current value,” which was allowed at the time. This goes to show how lax lending was in 2006-2007.

Within months of the purchase he was able to pull out all of his total down payment plus $100k when you combine the first and second. He now has total liens of $1,005,000 on a property that was purchased for $910k a year and a half ago and with a current value of approx $895k.

For those of you who are not aware, on first mortgages and HELOCs it was common for banks to allow a new appraisal for valuation purposes and not rely on the purchase price even if the new value was considerably higher. At many banks, this could be done immediately following a purchase. I am not sure what BofA’s policy was at the time, but obviously he was allowed to put a HELOC of $100k greater than the purchase price of the home not long after the original purchase.

As of a few weeks ago, he had not used all of the line and was worried about BofA shutting it down like most other banks have done. The money was his “rainy day fund.” So, he went to a BofA branch and pulled a cashier’s check for $100k and maxed-out the line. The manager had to come out and sign off and she even put him through a light question and answer session. He said she acted a little “concerned.”

Regardless, what the heck is BofA doing allowing a borrower to take out $100k cash on an essentially an UNSECURED Home Equity Line of Credit to 111% CLTV in this market? The borrower is “prime” when looking at his credit score but is salaried in a profession that does not support a million dollars in loans. In addition, he does not have a banking relationship with BofA of any kind. All that he has is a big, fat, open, fully accessible HELOC to 111% of present value.

Values are dropping so fast the banks can’t keep up with it so in the past six months most large-named banks have shut their borrowers out from accessing available credit in what they deemed “declining value” regions. That is most of American now days.

The question I have to ask is if BofA is this far behind the risk curve when it comes to HELOCs, which are front and center, what else are they dropping the ball on? The HELOC issue should be a no-brainer.

I am certain BofA will shut down most HELOCs in the near future, they would be foolish not to. Until that day, the smart ones will continue to max out their HELOCs and in many cases will never have to repay the money. - Best, Mr Mortgage

Other Related Mr Mortgage Reports

Dr Martin Weiss confirms Negative Outlook on WaMu and Wachovia

S&P Does Hatchet Job on Prime, Alt-A and Subprime RMBS

Mr Mortgage: June CA Home Sales Report

Mr Mortgage: June CA Foreclosure Report

Mr Mortgage: Mortgage Implosion Round 2: The Pay Option ARM

Fannie/Freddie: Massively Underestimated Risks

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43 Responses to “Is Bank of America Behind the HELOC Risk Curve?”

  1. IMO, it will be 12-18 months before these HELOC portfolios start to really look bad. The lenders that don’t have POA’s on their books will be giving the appearance for 3-6 quarters that they have made it thru the mess intact.

  2. great post. I am wondering, do the banks opt to completely write this loss off and issue a taxable 1099c to the borrower or do they pursue the borrower through conventional collections? also, what r the chances that a HELOC would foreclose knowing they’d get nothing in the sale? can you just call their bluff and just keep paying the first and bankrupt protect yourself from future collection activity? what I find interesting is the the ‘forgiveness’ in some of these principle write downs. I hear that the difference ends up becoming added to your taxable income. if that is the case consumers will be saddled with unexpected and exempt IRS debt.

  3. > what else are they dropping the ball on?

    Come now my friend you know the answer to that… that would be the Countrywide acquisition, whereby they gain exposure to all the various forms of toxic waste they “forgot” to originate in the mania itself.

  4. the explanation may lie in differing motivations, employees at bank branches are rewarded for lending money, not cutting off access to it, and it may take awhile for changing conditions at the top to filter down to the rank and file . . . kind of like the apparat in the old USSR

  5. Interesting Richard.

  6. This is the issue I am concerned about with Wells Fargo. I have all of my money, business accounts, and brokerage investments with them and am considering chopping everything up into nice FDIC-insured pieces at multiple places. Don’t really want to but may do so but it’s hard to figure out where to move to for national banks as they all have some type of warts.

    HELOCs were pushed heavy by Wells – I had a mortgage with them but refinanced with another lender earlier this year, in part because they were being very conservative on appraisals and rates in my area and were making a refinancing tough so I think they went conservative (at least on the loans they originated) earlier than most.

    But on HELOCs I would guess they are overexposed relative to their peers with west coast home equity loans and therefore are probably in worse position.

  7. With mortgages, the borrower can simply mail the keys in. With a HELOC, you can’t shed the debt without a bankruptcy. I suspect that most will continue to pay even though it hurts.

  8. Interesting. My primary is with Countrywide and yesterday I received a letter from them stating I had an enormous amount of equity and they would like to discuss how I could tap into that.

    You would think that this behavior would stop in today’s mortgage world, but hey, if it is going to eventually land in BOFA books, then I guess the sky is the limit.

  9. Question – If a bank gives someone a HELOC, say $100k, and then later realizes the borrower isn’t putting the money into the property, can they somehow get that money back pronto?

    Do they ever follow-up on a loan to see if the money is actually going into the property?

  10. By the way, Mr. M, alongside your external anecdote I would like to offer an *internal* one.

    I hear from people inside BoA – finance people – that the bank is not “at all cutting back on credit products.”

    Ken Lewis is a perma-bull on the overall economy; there are signs of this; and I’ve blogged on it.

  11. One word for BAC/CFC, Winstar

  12. Captious – Ken Lewis will get hurt then. He did a great job escaping the majority of the mortgage pain other than helocs, but he better be careful going forward.

    By the way, you do not have to spend the money drawn from the heloc on the home. Banks advertise to ‘take a vacation’ or ‘buy a car’ with the money.

  13. bithead,

    I have my 30yr fixed 5.5% with Countrywide, and a credit score in the 90th percentile – CW is dying to give me money, along with daily e-mails from my credit card companies, etc. Interesting though, with the decline in property values, three years ago, I was offered close to 200k with CW, now I am down in my offers to 100k (nothing else has changed in our financial picture). I could easily put myself (family) under water in my home – it is as if they want me to, given the current economy, I have no idea how I could pay the debt service on an additional 100k…..they have learned nothing, except the govt. will back stop them….nice :)

  14. In terms of what other items B of A might well be behind the curve on, given the whole Parmalat episode a while back it’s pretty clear to me at least that there management of international relationships was pretty shoddy.

    Tony Buzan

  15. Here is another article on Bank of America’s central role in the scandal, which brought the entire Italian banking system to its knees.

    http://www.buzzle.com/editorials/1-15-2004-49493.asp

    Tony

  16. Is it correct to assume that your friend is a great example of the people we taxpayers are going to “bailout” and absolutely should not bailout? Will rules on the $300 billion rescue package allow this person to refinance at a fixed rate for a mortgage amount at or probably even less than $895K? Your friend keeps the $100k, and stay in their house.

    As for the HELOC, I’ve no clue what the rescue bill does about those. I guess I need to read up.

    But I think your friend is a good example of those who should not be helped by taxpayers in the $300B rescue plan. Then maybe I’m wrong and your friend could plead ignorance about the housing bubble and say they just did what seemed reasonable at the time. After all everyone is doing it. Of course millions of renters didn’t do this. And they will pay for it. I didn’t do this. Millions of Americans with mortgages didn’t go bonkers by taking on housing debt… Now I’m ranting. But I would like your views.

  17. Evil-A, the lenders are doing what they do best… lend money. If they stop lending money then they go under themselves. That is how they make their money. It is not unlike builders today. They know that there is too much inventory and prices are going down rapidly. Even their own industry is at its worst level ever for confidence, but yet they still build. That is because like banks who still lend, building is what they do. If they stop then they go under. That is how they make their money.

    This is the problem when you have over capacity which leads to over development which leads to too much stuff. It doesn’t matter if its loans, homes, clothing, cars etc. We simply have too much of everything right now.

    We are now seeing workers getting let go at a much more rapid clip. This will bring down capacity which in turn will decrease the amount of development and eventually slow down the amount of everything. This cannot be stopped on a dime like they wish they could do however. You must ramp down slowly and curtail everything in a methodical manner.

    The bad or sad news is that during the run up we so overbuilt and overspent that we now will have a giant lull before we can use up what we have. This means a long and serious lull before these jobs will be needed again. Unemployment will surge much higher as a result of this. With a lot less people wanting to, or being able to, purchase all of this stuff we will see prices continue to fall as well. It is almost a self perpetuating affect.

    Fewer purchases = fewer jobs = fewer purchases = fewer jobs etc.

    We must take a giant bite out of the inventory hang over we now have (and it is going to get much worse). Until we can do that jobs cannot be created and a turn around cannot be expected. This is where we are at now…

  18. “I am certain BofA will shut down most HELOCs in the near future, they would be foolish not to. Until that day, the smart ones will continue to max out their HELOCs and in many cases will never have to repay the money.”

    MR. Mortgage,

    I don’t understand? This is a post that relates to me 100%. At the moment I still have an untapped HELOC with BOA too. Are you saying I should just cash this HELOC out without having to ever pay it back??? WTF? I can’t believe I heard you say this?

    What if i never use it? The bank can’t just close it. Or can they??

  19. Od, he is not suggesting that YOU will never have to pay it back, but rather any of those that end up going under will never have to pay it back. If you are treading water and could use some money to help you get started over then tapping an existing heloc will accomplish this for you. So before you walk away, you grab all of the money you can in your heloc. Once you walk away the home will not fetch enough to pay back both creditors and in many cases not even completely the first one. The heloc (2’nd lien) is not legally entitled to a dime until the first lien is paid back in full. So in many cases seeing as how there won’t be enough to do so, the holder of the second lien (heloc) gets nothing. Many banks have frozen all heloc lines so this won’t happen to them and especially in major bubble areas. A heloc is a line of credit and can be frozen at anytime if the bank chooses to. You are not entitled to this money as it is not yours. It is a loan in theory with your home used as collateral. You can’t sell your home until it is paid back and if you are not going to default then you will indeed have to pay this money back. It isn’t free to the prudent homeowner, but in essence is free to the underwater homeowner filing bankruptcy. They in the end will never owe that money or much of what their mortgage had left on it after the REO sale. In fact if you want to know WHO will pay this money back then just look in the mirror…

    That is correct YOU and I the American Tax Payer will pay this money back via the Fed off course as we the American Tax Payer buys up all of these foreclosures and continues to allow anyone holding mortgage paper to come to the lending window and drop of there mess of worthless paper in exchange for our tax dollars.

    What a country huh???

    Remember who got us into this mess and VOTE EVERY INCUMBANT OUT OF OFFICE IN 2008!!!

  20. Thanks, Stu.

    I’m in no trouble what so ever. I only set up the HELOC for “emergency” money.
    The line of credit is way above the value of my house now. Did you say the bank can adjust this amount, or just freeze it?

    If so, why even have one?

  21. Maybe I’ll use it to pay the tax increase coming in the future! LOL!

  22. The Banks review home values in areas around the country and simply send you a letter in the mail telling you that your HELOC has been frozen. Just like that you have no access to anymore funds from the account. If you owe some on it then it obviously needs to be repaid, but as you draw it down you still have no access to funds. They simply blanket entire areas with these letters and do not look at home by home situations for who should or shouldn’t have an open account. That would take forever and still not prove anything as the area could loose 5% more in value the following month. If you have one and it is not frozen then you must decide before it gets frozen if you think you would need that money down the line. It is basically a loan at a lesser interest rate than say a personal loan through a bank might be. If you don’t feel you will need it then leave it be, but realize it may get frozen at some point in the very near future and will no longer serve as a place to go for cash if needed.

    Many took them out for home repairs, upgrades etc. that they wanted to do. They are more flexible than say a personal loan that must have a finite amount attached to it. HELOC loans have a ceiling of which you do not need to reach, so you simply borrow what you need and then pay that amount back while still having funds available for other stuff you may be planning on doing. Others used them to consolidate loans at much higher interest rates from say CC’s and the like. While some idiotically bought cars and went on trips with the money putting their homes in jeopardy by buying a depreciating asset and causing there home to perhaps become one as well once the market turned on them. They now own a car woth less then they paid for it and equally a home now worth less. Not a smart move…

  23. Not only are they cutting off HELOCs, but cutting off credit cards as well. Amex has cut mine from $10,800 to $8,000 to $7,300 over a 6 month period. Citi has cut one of mine from $7,300 to $3,930 in the last month, apparently because I missed a payment by a couple days. Finally, BAC sent me a letter yesterday cutting one of mine from $5,000 to $4,100. I am never late (except that one time to citi, punched in the wrong date for billpay) and always pay well above the minimums. My credit report shows NO missed payments.

    BAC has also increased my other card with them from $10,800 to $13,000. I guess I’m not that much of a risk after all? Who knows, maybe they’ll turn around and cut that one too.

    They aren’t offering many low-APR cash advances anymore, else I’d withdraw all of my avail credit and store it to keep them from lowering them anymore. I don’t need the high limits, but if they keep pushing down, it keeps making my credit look worse (higher balance ratios) and causing more downward pressure. I probably have too much avail credit anyway, but I’m responsible with it and it hurts my credit score when they keep cutting.

    I feel a wave of bankruptcies coming.

  24. Oh, and I forgot to mention, my second mortgage is with Countrywide (was sold to them by SunTrust). SunTrust has my first. At least once a week I get either a letter or email from Countrywide telling me I am a responsible borrower and to call them about refinancing my first with them.

    Guess they might be scared that they will lose that second mortgage if I stop paying?

  25. All sorts of sh&% is happening right now…

    Frozen HELOC’s

    No more leasing vehicles

    Not doing mortgages any longer

    Canceling over draft protection

    Not funding school loans

    Not issuing insurance

    No more 80/20’s

    No more Pay Option loans

    Cutting CC limits

    Stopping cash advances

    Not accepting CC’s

    Points for low credit scores

    Income verification mandatory

    Higher down payments required

    Many, many bankruptcies are on their way. Some have already happened (insolvent), but have yet to be officially announced. Today is Friday however so keep your ears and eyes open…

  26. I guess being financially conservative is finally paying off.
    Of all the things on that list, most have never applied to me …but are they seriously getting rid of points for low credit scores?? What is the point in have a credit score then? (No pun intended)

    Hyper-deflation here we come!

  27. od, grab a WSJ and look at page C12. There is a story on HELOC’s today. Currently banks are holders of roughly $700 Billion worth of them…

  28. anyone heard anything on WB today? seems to be an outlier

  29. I meant that you must pay points if you have a low credit score. When was the last time you heard points mentioned in mortgages? Heck, lenders didn’t even require you to put money down and they covered the cost of the closing in some cases. Now to help cover the higher assumed risk on these loans points are now back in vogue…

  30. “Currently banks are holders of roughly $700 Billion worth of them…”
    Funny how the bank’s stock keeps rising..??

    ..a window to bail out of possibly??

  31. Stu – I completely agree, it is what they “do” I just laugh at how much money is being offered to me still and yet, because my credit score is (929 – trans union), and I use very little of what is offered, but that is why my credit score is what it is – I have never borrowed what I could, never would….unless I enjoyed living in a card board box – I am just cheesed that I get to help pay for this “too much” everything :)

    Alex – if you have really good credit, and you made a key punch error – I would be on the phone very quickly with “Citi” because that is hurting your score more than the amount of credit limit they are taking away – if you really are as good as a customer – I think a little desk pounding is in order. IMO :)

  32. evil-A – I’ve tried, on multiple occassions. All they tell me is that it’s a standard procedure and that the account is reviewed automatically every six months, so if anything were to change in my “credit risk” the limit would increase on its own. I gave up and I’m not about to cancel the card and screw my score further.

  33. That’s what is so pointless about a credit score.

    All it rates is how reliable you are at making payments, and how much you like to borrow. It’s got nothing to do with how financially responsible you are.

    Your score doesn’t even go up if you pay off /back your debt!! Not to mention if you stay out of debt.
    In fact, if you don’t borrow, your score goes down.

    The worse your score is, the more offers you will get. (As long as you make payments.)

  34. We should be clear on the risk profiles of HELOC borrowers. MortgageMan your friend who put the 20% down is statistically, even in the past two years, a good borrow risk. He is in somewhat of a dangerous position in that his HELOC is with recourse much like a credit card.

    Those that used 80/20s (a HELOC behind an 80% LTV first mortgage) to ORIGINALLY purchase a house are a substantially higher credit risk of several orders of magnitude. That HELOC used to purchase is without recourse, and borrowers that never put money down are much much more likely to default and walk away.

    Unfortunately, a significant number of HELOCS were used for purcase, especially in the bubble states, which does not bode well for banks doing business there.

  35. Alex,

    It’s a myth that your score goes down after canceling a card.
    It only goes down if you close the card with outstanding debt.

  36. od – no, it goes down, because your balance ratio goes up. If you have $5,000 balance across all cards, with a max limit of $20,000 on all cards, you have a 25% ratio. If you close a $10,000 card, you now have a 50% ratio, and that will draw down your score pretty heavily. If you carry a higher revolving account balance ratio, you’re considered higher risk.

    At least, that’s how I’ve always understood it.

  37. Yes Alex, and addition OD you cancel the card (obviously after being paid off) in written form and make sure that it is clear that it is your choice not that of the bank – why pay anything to a company that will not work with you, but that’s me

    Although I do disagree a bit on the fico score thing, while I realize you can be in college and have a high credit score which means nothing, you do (I am pretty sure) get credit for paying off debt (on time), and yes if you have no debt you never develop a score, or how often you use and pay off debt. There are tons of factors, and many that make no sense, My dad’s wife actually worked with fair issac way back in helping to develop this system, (albeit very flawed!!!)

  38. My overall conclusion is that the FDIC insurance fund (DIF) will soon be exhausted, and the FDIC will have to borrow from the Treasury to cover insured losses. This will lead to over-issuing of Treasury debt, which will cause Treasury bond prices to drop and interest rates to rise. The last bubble to burst will be the “safe” Treasury bonds, because that is the final back-stop to this entire financial system house of cards.

    Final backstops always finally fail.

  39. There are many people who have no liens on their homes and should be given HELOCs.
    There are many people with little or no equity in their homes and should not be given HELOCs.

    The problem is that back in the 1990’s, the banks laid off most of their loan officers who could make the call and now just push paper.

    They are all still dancing but lack the skills to avoid the ‘holes’ in the floor.

  40. Well said fedwatcher!!!

  41. Stu
    ‘but in essence is free to the underwater home-owner filing bankruptcy’

    I think you miss the point. People who walk are not planning on bankruptcy. They are just taking advantage of the stupid rule (in the sense that it engenders world financial instability due to over borrowing) in many states that mortgages are non -recourse and all walkers suffer is a temporary bad credit rating (and can even mitigate that if they buy a new house with
    mortgae before they walk, so stupid are the banks).

    So probably walkers cannot avoid their Heloc debts as they are recourse, unless they are happy with bankrupcy.

    Advice to max your Heloc is only wise if you are desperate for money (and only moral, ie worthy for Mr Mortgage to recommend, if you are not facing / planning bankruptcy) .

  42. G Cox, I thought if the Heloc (80/20) was used for the primary purchase then it was not a recourse loan. Only if a Heloc is taken out after the mortgage does it fall under the same rules as say CC debt and is fully recourse. At least that is the way I understood it to be, but I may be incorrect on that.

  43. I’ve heard from a real estate appraiser here that she is doing appraisals for BK attorney’s now and that they are petitioning the BK court to discharge the HELOCs due to them not being secured by the house anymore since a drastic drop in value which is why they order an appraisal to prove it. Anyone else heard of this?

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