The Federal Deposit Insurance Corp. on Monday issued a letter to banks calling for new considerations when estimating credit losses on junior liens on one- to four-family homes.
The letter calls for quarterly adjustment of loan loss allowances related to these estimated losses, indicating banks may soon have to beef up reserves if heavy losses are expected on junior liens.
The FDIC is urging a historical perspective in estimating losses on these loans, including history of a borrower’s repayment status regarding first liens and any delinquencies or modifications. The letter also asks banks to consider changes in the value of underlying real estate collateral.
A significant item of inspection included in the letter is the collectibility of junior lien loans and whether underlying collateral is sufficient to protect the junior lien position in a foreclosure proceeding initiated by a senior lien holder.
“Failure to timely recognize estimated credit losses could delay appropriate loss mitigation activity, such as restructuring junior lien loans to more affordable payments or reducing principal on such loans to facilitate refinancings,” the FDIC said in the letter. “Examiners will continue to evaluate the effectiveness of an institution’s loss mitigation strategies for loans as part of their assessment of the institution’s overall financial condition.”
The letter arrives on the heels of a push from lawmakers to reconsider the value of junior and second liens held on banks’ balance sheets. Without accurately estimated loan losses, some second lien holders resist modification efforts, the lawmakers said in a letter.
Senate Banking Committee chairman Chris Dodd, D-Conn., and House Financial Services Committee chairman Barney Frank, D-Mass., in mid-July dispatched a letter to the heads of bank regulators, calling for action on the issue of second liens.
“Carrying these loans at potentially inflated values may contribute to resistance on the part of servicers to negotiate the disposition of these liens, and thus may stand in the way of increasing participation” in certain modification programs, the letter said. “Inadequate reserving would also overstate the capital position of these institutions at a time when an accurate picture of the capital adequacy of the banking system is crucial.”
Banks Urged to Consider Higher Home-Equity Reserves (Bloomberg)
The regulator, in a letter today to banks and examiners, urged lenders to consider issues such as whether borrowers’ total housing debt exceeds the value of their properties and whether homeowners’ first mortgages have been reworked when determining allowances for losses on the debt.
Senate Banking Committee Chairman Christopher Dodd and House Financial Services Committee Chairman Barney Frank in a letter last month asked regulators to assess whether banks are carrying home-equity lines of credit, or HELOCs, and non- revolving home-equity loans at “potentially inflated values,” hindering efforts to have mortgages modified to stem the soaring foreclosures that have roiled the U.S. economy.
“It was probably triggered by the fact that the FDIC does not like what it is seeing with respect to marks on the HELOC books,” Paul Miller, a bank analyst at FBR Capital Markets in Arlington, Virginia, said in an e-mail today.
A drop in values has left about 22 percent of the nation’s 93 million houses, condos and co-ops with mortgages that exceed the value of the properties as of March 31, Seattle-based real estate data service Zillow.com said in a report May 6. Banks held a record $674 billion of HELOCs and $211 billion of closed- end home-equity debt as of March 31, according to FDIC data.
Mortgage-bond investors including Fortress Investment Group have complained to lawmakers that banks making loan-modification decisions have ignored suggestions to cut balances of more homeowners because other types of changes in first-lien loan terms don’t require the banks to report losses on their holdings of home-equity loans.
“Failing to properly consider the current effect of more senior liens on the collectibility of an institution’s existing junior lien loans is an inappropriate application” of accounting principles, the FDIC said in the letter.
JPMorgan Chase & Co. and Citigroup Inc., both based in New York, Wells Fargo & Co. of San Francisco and Charlotte, North Carolina-based Bank of America Corp., the four-largest mortgage servicers, own almost $450 billion of home-equity loans, according to analysts at Amherst Securities Group.
The FDIC said failing to recognize credit losses “could delay appropriate loss mitigation activity, such as restructuring junior lien loans to more affordable payments or reducing principal on such loans to facilitate refinancings.”
The letter reminds industry that loan-loss allowances “should be reflective of credit conditions that impact their portfolios,” LaJuan Williams-Dickerson, an FDIC spokeswoman, said in an e-mail. “Recognizing those conditions allows lenders to make good decisions and work with their borrowers, based on realistic economic circumstances.”
Tom Kelly, a JPMorgan spokesman, and Scott Silvestri, a Bank of America spokesman, declined to comment. Mark Rodgers, a Citigroup spokesman, and Kevin Waetke, a Wells Fargo spokesman, didn’t return messages seeking comment.
Home prices in 20 large U.S. cities have dropped 32 percent on average since peaking in July 2006, according to the S&P/Case-Shiller index. Writedowns and credit losses at the world’s largest financial companies have reached more than $1.54 trillion since subprime-mortgage defaults began rising in 2007, according to data compiled by Bloomberg.
Mortgage-bond investors are seeking greater use of the Federal Housing Administration’s Hope for Homeowners program for loans backing their securities, Curtis Glovier, a managing director at the New York-based Fortress, told lawmakers at a hearing last month. Banks acting as loan servicers, managing outstanding mortgages, have blocked such action, he said.
Under the program, borrowers with “negative equity” get part of their mortgages forgiven as they refinance into government-insured loans. It was created last year and revised in May by Congress to encourage participation.
The program requires a holder of home-equity debt to accept a pay-off representing a small amount of what’s owed, while other steps to change terms keep the debt “on the books of the financial institution as a performing asset,” Glovier said, speaking for the Mortgage Investors Coalition, formed in April to represent 11 firms that manage $200 billion of assets.
Bank of America had an allowance for home-equity losses equal to 5.59 percent of its $155 billion portfolio as of June 30, according to slides from a July 17 earnings presentation posted on the lender’s Web site. Nonperforming debt represented 2.56 percent of the portfolio; debt at least 30 days delinquent and not deemed “nonperforming” totaled 1.29 percent.
Half of the portfolio was tied to borrowers whose debt exceeded 90 percent of their property’s value, with 41 percent tied to Florida and California homes, according to slides.
Wells Fargo said last month that 2.65 percent of loans in its $117.5 billion core home-equity portfolio were two payments or more past due at the end of the second quarter, up from 2.53 percent the previous period. The annualized loss rate rose to 3.25 percent from 2.09 percent; loans in California and Florida make up 37 percent of the portfolio. The bank has an additional $9.35 billion of home equity loans that it’s liquidating.