Although some observers have pointed to the problems posed by second liens in foreclosure prevention, little attention has yet been paid to concentrated home-equity loan risk. Since the only way to modify first liens is usually by gutting the second, banks with high concentrations of second liens will face big losses that few can afford. We’ll get to whose at most risk in a minute, but it’s also important to ask just how so many banks could have gotten so big into bad loans without regulators uttering a peep. To be sure, the agencies issued some guidance in 2005, but it was barely a bump on the road to exploding second-lien portfolios.
Now, some banks with big second-lien books are among those closed by the FDIC; soon, many more will have to join them. Although second liens are called “home-equity loans,” most are nothing but air. Whatever equity was in them at origination – and it wasn’t much due to all the piggyback mortgages booked during the boom – is gone in the wake of the house-price depreciation in the bust.
Data in today’s American Banker on home-equity loan concentration are a sobering read. It isn’t that we hadn’t recognized the risks seconds posed – we’ve long argued that loan-to-value (LTV) ratio is the mortgage credit-risk driver, not credit scores or some of the other underwriting criteria in which lenders and investors once put so much faith. However, a look at the bank-by-bank data shows how much the regulators – principally OTS – let banks bet on this often-ephemeral sector. It’s not that the regulators didn’t know that seconds were risky – see the ignored guidance above – or that concentrated risk is problematic – they’ve been talking about it for years – it’s just that nothing was done.
The big winner in the home-equity betting parlor is a small bank in Eden Prairie, Minnesota – doubtless lovely this time of year – which has 84 percent of its total loans in second liens. De mortuis, and we’d say the same for several other small institutions with big books of second liens likely originated in connection with high-LTV loans where first liens were sent to Fannie Mae and Freddie Mac. However, the bigger savings associations with huge bets on seconds can’t be so readily disposed of without exacerbating the FDIC’s already-crowded problem list.
Among the large institutions with serious amounts of concentration risk in seconds is USAA – a savings association now figuring prominently in the Hill debate as it wiggles out of new FRB prudential rules. USAA – an OTS-regulated entity – has $11.6 billion in seconds, taking up 43 percent of its loans and reflecting a bet of 380 percent of its Tier 1 capital. That’s right – almost four times its capital is bet on residential seconds. Given that USAA focuses on military borrowers, much of this is likely in the low/mod-income segment with particular concentrations in Sunbelt areas. Oops.
Number ten on the home-equity concentration list is Charles Schwab’s thrift housed in Reno. It’s got $3.1 billion in seconds – actually more than it had this time in 2008 – with these loans amounting to 46 percent of its total loan book and 130 percent of its Tier 1 capital. Two other large institutions that caught our eye are E*Trade and First Horizon. E*Trade’s book of seconds is $9 billion, or 35 percent of its loans, and First Horizon is sitting on $6.2 billion, which comes in at 31 percent of total loans. Again, second-lien risk exceeds Tier 1 capital.
We could go on – there are other good-sized banks with monster second-lien books, but the point is clear even from those we’ve noted so far. Regulators saw this coming, looked the other way and allowed insured depositories – mostly thrifts – to bet multiples of their capital base on the riskiest type of mortgage loans.