Many of the loans were not made originally by these banks, but instead by entities they took over, such as Countrywide, Bear Stearns, Wachovia and Washington Mutual. Greg Hebner, President of MOS Group, which advises many of the large banks, said that not all of the money on the balance sheet is at risk because the government agreed to share some of the losses. Yet he does think current balance sheets do not reveal the true risk banks hold in equity lines and loans.
Government data indicates that just $11.1 billion in home equity loans and $19.9 billion in home equity lines were written off in 2009, but that is just a drop in the bucket when you consider that homeowners nationwide borrowed a trillion against the equity in their homes and used them as a piggy banks to buy cars, boats, recreational vehicles and so on.
Steven Home, CEO and Co-Founder of Wingspan Portfolio Advisors, which works with second lien servicers, says the entire second lien market changed dramatically beginning in the late 1990's. Prior to that only people with top credit could get equity lines. All this changed when 125 percent equity lines were introduced and pushed by Countrywide and others. Even those loans still only went to people with FICO credit scores of at least 700. But next came Piggy Back equity loans, which allowed people to buy homes with an 80 percent first lien and a 20 percent second lien, either as an equity line or equity loan.
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Soon after these riskier second liens gained in popularly, underwriter guidelines became weaker and weaker. Hebner said Wall Street wanted mortgage-backed securities to sell and the banks helped make it happen even if it meant making riskier loans.
Today both Hebner and Home work with the banks to mitigate losses from these loan anybody money days. People took money they obviously couldn't afford. "This shear lack of financial literacy is an economic risk for this country," Hebner said. But shouldn't the banks have served as financial advisers to help people understand the risks they took?
Hebner works primarily with first lien holders and Home primarily with second lien holders. Under today's guidelines second lien holders are left holding the bag with a capped recovery of just 6 percent of the loan value or $6,000 if a home is underwater no matter what the dollar value is of the second.
For short sales, first lien holders take a hit, but second lien holders are getting 10 cents on the dollar or less. Yet there may be some good news for the future. The American Bankers Association's first quarter report on consumer loan delinquencies indicated that delinquency rates for most types of consumer loans are improving. Even home equity loan delinquencies fell from 4.32 percent to 4.12 percent. Home equity line delinquencies fell from 2.04 percent to 1.81 percent. Yet even with this slight improvement home equity loans have the highest delinquency rates of any consumer debt.
Bank card delinquencies fell below 4 percent to 3.88 percent for the first time since 2002, but I wonder if that's more related to aggressive write offs by the banks in the past few years of credit card debt than it is to significant improvement in paying customers? Banks are not writing off home equity debt as aggressively as credit card debt both Hebner and Home agreed. Many are letting underwater equity lines and loans sit on the books even thought the banks know the underlying assets are no longer worth what they were when the loans were made. Banks do not change the book value of equity loans and lines as long as the loan is being paid on-time.
But the big question is whether these loans will continue to perform? With 20 million homes projected to be underwater by the end of 2011, more and more people may consider walking away. People with homes deeply underwater that make a strategic decision to default do so with little warning. They tend to pay all debts on time until they make the strategic decision to default and then just stop paying their mortgages, while many times still paying other debts on time. These strategic defaulters could also have some of the highest value second liens because they tended to use Piggy Back loans to buy with 0 percent down or borrowed significantly using equity lines to buy other toys (like boats, cars and recreational vehicles) as their home value inflated.
So the big question is have the banks adjusted their balance sheet to reflect this risk? While no outsiders knows what's in the bank's balance sheet numbers as they relate to existing equity lines and loans, Home does think they are overvalued. The only question now is when will the next shoe fall for the banks.
Equity lines are consumer loans they can be wiped out completely in a bankruptcy judgment. Even in recourse states banks have no recourse if the consumer files bankruptcy. That's one big reason banks are settling for 10 cents on the dollar or less with underwater homeowners as they try to modify their loans. What will happen when more underwater borrowers realize this settlement option is out there?
Lita Epstein has written more than 25 books including Reading Financial Reports for Dummies and The 250 Questions Everyone Should Ask About Buying Foreclosures.
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