HELOCs: The Next Debacle?

I think we all know what this means, don't we?

A significant amount of home equity lines of credit will reach the end of their draw period beginning in 2014, about the same time the Federal Reserve plans to end its downward pressure on interest rates.

The Office of the Comptroller of the Currency released its first semiannual report on threats it sees to the banking sector. Included are still elevated levels of foreclosures, loosening underwriting standards and a wave of new products these firms are beginning to venture into.

But past loans could still raise major problems as well.

In 2012, roughly $11 billion in HELOCs reached the end-of-draw period, marking the moment when a borrower can no longer draw equity from their home and must begin paying back the principal plus interest.

By 2014, this number grows to $29 billion, nearly doubles in 2015 to $53 billion and could reach $111 billion by 2018, according to the OCC.

[...]

The OCC said because home prices in many areas are still slow to recover since these loans were originated, many borrowers will struggle to refinance. This translates to heightened risk for banks still trying to untangle their balance sheets from the latest housing bust.

"Approximately 58% of all HELOC balances are due to start amortizing between 2014 and 2017," the OCC said. "Housing price declines have led to questions for the banking industry about carrying values and allowance levels that support home equity portfolios."

So, here's my uneducated guess: those banks with a heavy (or, even, not-so-heavy) portfolio of HELOCs are going to be examined with an electron proctoscope for potential weaknesses, real or imagined. After all, everyone knows that the last financial crisis was caused by lenders having granted credit to borrowers. Compounding the insanity of credit-granting is the fact that HELOCs are secured by second liens on residential real estate, and borrowers can pay down the principal and (GASP!) re-borrower it. I know, it's absolutely crazy.

In many parts of the country, including portions that might not number among the usual suspects, HELOCs will be considered "high risk" and banks will be examined carefully to ensure that peach-fuzz-faced examiners are satisfied that credit officers who've been making HELOCs since decades before the examiners were even gleams in the eyes of their fathers are "competently" managing the risk. And if the worst comes to pass, and many HELOCs crash and burn, examiners who the previous year found that bank officers were adequately managing the risk will suddenly determine that those same officers were not only negligent from the get-go, but are the kind of folks who probably shouldn't be allowed to breed.

Hey! This is just another cycle in the wonderful world of arm chair quarterbacking to look forward to. The product changes, but the examination wheel turns full circle, year after year after year.

Comments

[Woodrow Wilson]

Great Blog...

This issue (HELOC) is nothing new, there's actually a great clip on "YouTube" of Adam Levitin of Georgetown Law testifying to CONgress that the exposure on HELOC's alone make entities with large exposure insolvent in a true mark-to-market world. Of course, we don't live in that world anymore.

Should be interesting if The Fed ever leaves ZIRP (which is doubtful) and interest rates blowout underwater homeowners on just HELOC's.