Friday, May 23, 2008

"Unprecedented Home Equity Loan Losses"

This eye opening HELOC press release from from the Comptroller of Currency, John C. Dugan has some pretty eye-opening statistics and data. The title alone - Comptroller Dugan Tells Lenders that Unprecedented Home Equity Loan: Losses Show Need for Higher Reserves and Return to Stronger Underwriting Practices sets off alarms. Here are some key parts:

Home equity loans and lines of credit grew dramatically in recent years, more than doubling, to $1.1 trillion, since 2002. In part, that’s because of the rapid appreciation in house prices, the tax deductibility feature of home equity loans, and low interest rates.
These relaxed standards included limited verification of a borrower’s assets, employment, or income; higher debt to equity ratios; and the use of home equity loans as “piggyback” loans that helped borrowers qualify for first mortgages with low down payments and without mortgage insurance, resulting in ever-higher cumulative loan-to-value ratios.
Looked at in dollar terms, losses on all home equity loans, including HELOCs and junior home equity liens, rose from $273 million in the first quarter of 2007 to almost $2.4 billion in the first three months of 2008 – a nine-fold increase. And the largest home equity lenders are now saying that they expect losses to continue to escalate in 2008 and beyond, Mr. Dugan said.


In assessing loan loss reserves for home equity loans, he said, banks need to recognize that they are in uncharted territory. “New product structures, relaxed underwriting, declining home prices, potential changes in consumer behavior – all of these factors make it difficult to predict future performance of home equity loans,” he said.
Circumstances have changed fundamentally, and historical trends have little relevance in estimating credit losses. As a result, qualitative factors such as environmental analysis and changing consumer behavior clearly should be factored into the reserve calculation. Likewise, lenders should take into account the very real possibilities that unemployment or interest rates will increase from their quite low current levels.

Times are changing. Unprecedented losses for HELOCs. Historical trends not providing accurate formulas. Things are going to get much worse before they get better. And this is coming from the Currency Comptroller.

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