Interest Rate Roundup

Wednesday, March 12, 2008

WSJ takes on the home equity loan headache

From the Wall Street Journal this morning:

"Here comes another headache for banks suffering from the mortgage downturn: Losses on home-equity loans are soaring, even at some lenders that avoided big blunders on subprime loans.

"When times were good, banks raked in billions of dollars in profit from home-equity loans, which allow borrowers to tap the accumulated value in their property with either a loan for a specific amount or a line of credit. As long as home prices were rising, lenders had little to worry about.

"But falling home values are leaving banks with little or nothing to collect on many home-equity loans in case of default. Some stretched borrowers are keeping up with their mortgage and credit cards -- but not their home-equity loan.

"The problems are already causing trouble for J.P. Morgan Chase & Co. and Wells Fargo & Co., and are expected to hit other large banks when first-quarter earnings results are released next month. The pain is likely to deepen through the rest of 2008, sapping capital levels and resulting in tighter lending standards as banks try to reduce their risk.

"These losses are well beyond what we would have modeled ... and continue to get worse," said Charles Scharf, head of J.P. Morgan's retail business."

The bottom line is this: Having borrowers with high CLTV ratios -- whether it's because they took out a 100% first, an 80% first/20% second split, or any other combination of loans -- is a recipe for big losses when home prices fall. It's also worth pointing out that second-lien lenders aren't exactly operating from a position of strength. As the WSJ notes:

"While banks can foreclose on a first-lien mortgage, lenders often have little recourse when trying to collect a delinquent home-equity loan, especially if another bank holds the primary mortgage. Banks holding home-equity loans generally can only seize the collateral -- a house -- after the mortgage is paid off.

"When another bank holds the mortgage and the mortgage payments are current, the home-equity lender is effectively powerless to collect the debt."

Meanwhile, even finance industry executives can't seem to find much good to say about the housing market. Richard Syron, the CEO of Freddie Mac, said today that this is "the worst housing market in a century," and added that we are only about 1/3 of the way through the home price decline. The chief risk officer at Wachovia, for his part, said the housing outlook "appears to be worsening," per Bloomberg, and has a "ways to go."


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