BOSTON—There is potential for a “big problem” in the offing with home equity loans, according to one person.
Aite Group Senior Analyst Christine Pratt is noting that a significant percentage of home equity loans inside portfolios at banks and CUs are coming to their 10-year end point, since the majority of HELOCs on the books were originated just before the financial collapse.
“There is a potentially big problem with home equity portfolios,” said Pratt. “That is, 60% of HELOCs need to be addressed by banks and credit unions between 2014 and 2017. Banks and credit unions have to be careful so home equity default rates don’t skyrocket.”
Pratt reminded that these borrowers took out their loans when their home values were high, likely still have large balances, as well as a sizeable first mortgage.
“You now have a problem with lower home values and have to adhere to lending rules that dictate how much collateral a borrower must have to take a home equity loan—and a lot of borrowers won’t meet the standards to receive a new home equity loan, which most of these individuals will need,” explained Pratt.
Decisions To Make
She said banks and credit unions have to have some serious decisions about what to do with this pool of borrowers, and that there is no clear path.
“This group of borrowers has paid well and has used the line, but now they can’t meet the collateral valuation guidelines for a new home equity loan? Do you rewrite or modify the existing loan?”
Pratt said it’s a vexing situation.
“Do you leave these loans on the books as closed loans?” asked Pratt. “What if the customer or member says they won’t repay, especially if their house is underwater? And the bank or credit union can’t even foreclose, since the home equity loan is in the second position. You don’t want to write off the loan, but you can’t give the borrower any more money. How do you keep them paying?”
Carrying the existing home equity loan without reworking it is certainly risky, noted Pratt. “It’s no longer secured. It’s almost like a credit card.”
Small FIs At Risk?
Pratt said the large financial institutions are well aware of the issue, but she is unsure if smaller ones are giving the matter their full attention.
“Some of the bigger banks are working with these borrowers to see if government assistance is available,” she said.
Cris DeRitis, senior director at Moody’s Analytics, New York, thinks the big FIs have the situation under control.
“At the end of the 10-year period on a home equity loan, we know, is when delinquencies rise,” said DeRitis. “There is always the risk of payment shock as loans are reworked and a different rate is issued. But banks are taking steps to convert these lines over to fully amortizing loans.”
Both Pratt and DeRitis noted that regulators have their eyes on this matter. Pratt thinks banks have already been experiencing greater regulatory scrutiny on this issue from the FDIC since development of their new capital rules have preceded credit unions.
But she is concerned that CUs will face increasing examiner scrutiny here with the new risk-based capital rule, and potential capital pressure from needing to increase loan loss reserves.
“With possibly a higher volume of non-performing loans, credit unions will have to pay much closer attention to their capital levels,” Pratt observed.