Bank of America Faces Bad Home-Equity Loans: MortgagesKathleen M. Howley and Dakin Campbell
Bank of America Corp., whose home-equity mortgage portfolio exceeds its stock market value, probably will say about $2 billion of junior loans are bad assets tomorrow even as some borrowers are still paying on time.
That’s what Barclays Capital estimates the bank will report in its first-quarter results, following decisions by JPMorgan Chase & Co., Wells Fargo & Co. and Citigroup Inc. to reclassify $4.1 billion of junior liens as nonperforming.
Regulators are pressing for the change on concern that falling home prices have wiped out collateral on many second mortgages, leaving them as unsecured debt. About 20 percent of the nation’s $845 billion of home-equity loans exceed the value of the properties when combined with primary mortgages, according to CoreLogic Inc., and about 36 percent of Bank of America’s were at least partly “underwater” at the end of last year, according to regulatory filings.
“The reclassification may change the way the investors look at the company but as far as the vulnerability it does nothing to take that away,” said Jeffrey Sica, the Morristown, New Jersey-based president of SICA Wealth Management who helps oversee $1 billion of assets and who’s bet on a decline in the shares of Bank of America in the past. “This is something they have very much tried to keep under wraps.”
Almost a quarter of homes in the U.S. were worth less than the mortgages against them, according to CoreLogic, the data firm based in Santa Ana, California. About 4.4 million had home-equity mortgages, the firm said.
Banks have been carrying some high-risk junior mortgages on their balance sheets at full value even after a rout in home prices stripped almost $7 trillion from property values, according to the Federal Reserve and other bank regulators. Executives including Bank of America Chief Executive Officer Brian T. Moynihan and Wells Fargo CEO John Stumpf have said borrowers tend to keep paying as long as they are able, even if home prices decline.
The risk for lenders is that if the borrower does default and the property is auctioned, a junior loan stands behind the primary mortgage for repayment. Typically, the second-lien holder suffers a total loss.
Investors are “trying to find the canary in the coal mine,” said Chris Gamaitoni, a mortgage and banking analyst at Washington-based Compass Point Research and Trading LLC. “Bank of America is certainly the most worrisome.”
Bank of America, which has the biggest home-equity portfolio in the U.S., may post a 6.9 percent decline in first-quarter adjusted profit to $1.62 billion tomorrow, according to analysts surveyed by Bloomberg. The Charlotte, North Carolina-based company had been the nation’s largest mortgage lender after buying Countrywide Financial Corp. and had a portfolio of $136.7 billion in home-equity loans at the end of last year, according to a company filing.
The lender was unchanged at $8.92 at 4:15 p.m. in New York trading. It’s gained 60 percent this year boosting the market capitalization to about $95.7 billion.
About 22 percent of the bank’s home-equity loans were actually senior liens at the end of last year, according to a company filing. That compares with about 28 percent at New York-based JPMorgan and 20 percent at San Francisco-based Wells Fargo. The figures at all three banks exclude impaired loans picked up in acquisitions.
Bank of America has identified $4.7 billion of home-equity loans that stand behind a delinquent first, according to a year-end filing, and the total reclassified as nonperformers may be higher than Barclays’s estimate, according to Brian Foran, a New York-based analyst at Nomura Holdings Inc. Citigroup moved about 2 percent of its home-equity portfolio, the smallest of the four lenders. At that rate, Bank of America would reclassify about $2.73 billion.
“I would expect BofA to be in the same ballpark and maybe slightly higher,” Foran said. “Given that they had identified and disclosed these loans ahead of time my guess is they will do the same as the others. The only question mark hanging over this issue: is it the last step, or the first step?”
The three companies collectively hold 40 percent of the nation’s home-equity loans, according to Fitch Ratings. Wells Fargo, the biggest U.S. mortgage lender, and JPMorgan, the biggest bank by assets, had already set aside reserves for the loans they reclassified as nonperforming, so there was no impact on reported profit, the banks said last week.
Still, the changes at the two banks “surprised and spooked investors, despite not having an earnings impact,” wrote Barclays analysts led by Jason Goldberg in a research note.
The Fed’s directive, which reiterated rules in force since at least 2006, isn’t enough to mitigate the risk junior loans pose to the banking system, said Rebel Cole, a former Federal Reserve economist and now a finance professor at DePaul University in Chicago.
“The guidance has absolutely no teeth,” Cole said. “The regulators could simply say, ‘We know at least 25 percent of first mortgages are under water, therefore, at least 25 percent of your second liens are uncollateralized and have to be classified as substandard or doubtful.’”
The risk of home-equity loan defaults will increase if real estate prices continue to decline, analysts and economists said. Home values have tumbled by a third since reaching a peak in mid-2006, according to the S&P/Case-Shiller home price index. Diane Swonk, chief economist of Mesirow Financial Inc. in Chicago, estimates home prices will retreat another 3.9 percent this year, which would strip $706 billion from home values.
Fitch estimates 20 of the largest U.S. banks, including units owned by foreign lenders, may face another $110 billion in junior-loan losses under a stressed scenario, according to a Feb. 27 report that cited third-quarter 2011 figures. Bank of America leads the group with $29.1 billion in potential losses, Fitch said.
While equity loans carry a higher risk if they default, delinquencies are lower. In the fourth quarter, 4.08 percent of home-equity loans were missing payments, according to the American Bankers Association in Washington. That compares with 7.58 percent for first-lien mortgages, according to the Mortgage Bankers Association in Washington.
Some of the difference is because of the way banks book second liens. Non-performing home-equity loans typically are written off in six months. That compares to an average two-year period from delinquency to a foreclosure sale on a primary mortgage. Also, home-equity payments are smaller, meaning homeowners are likely to keep paying after a default on their primary mortgage -- at least for awhile.
“When we analyzed it, it was pretty obvious it was just a timing difference,” JPMorgan CEO Jamie Dimon said. “In almost all cases when the first went delinquent, the second eventually went delinquent. And in all cases where the first went into foreclosure, the second was a loss, basically a total loss.”
Jerry Dubrowski, a Bank of America spokesman, declined to comment, as did Wells Fargo’s Mary Eshet and Citigroup’s Mark Rodgers. Amy Bonitatibus, a JPMorgan spokeswoman, declined to comment beyond Dimon’s remarks.
“We’re seeing the lingering effects of the housing market bust,” Swonk said in an interview. Guidance from regulators “is the reality of making sure banks are sound and secure while we work through the ripple effects of the financial crisis.”
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