Second Liens and Home Equity Loans

All of the mortgages we 've looked at so far, as toxic as they might be, are at least first mortgages (or first liens), meaning that if the borrower defaults, the lender can foreclose on the house and sell it, thereby recouping some of the loss. But this isn' t so in the case of a home equity line of credit (HELOC) or a home equity loan, (these loans are also known as a second lien, second mortgage, closed-end second (CES), junior lien, or closed-end junior lien).

A HELOC is a line of credit that a lender extends to a homeowner based on the supposed equity in the home. There 's a cap on the amount that the homeowner can borrow and the interest fluctuates, usually based on the prime rate plus a certain margin. A HELOC offers the homeowner a great deal of flexibility in terms of the amount borrowed and when to repay the loan—most HELOCs only require that interest be paid until the end of the so-called draw period (typically 5 to 10 years), after which the loan amortizes (i.e., must start to be paid off).

By allowing Americans to borrow against the rapidly rising value of their homes, HELOCs facilitated an orgy of spending. For example, in 2007 30 percent of new car purchases in California and 20 percent in Florida were funded with HELOCs.11

A home equity loan differs from a HELOC because it's a one-time, lump-sum loan, often with a fixed rate. It is generally taken out as part of a financing package that includes a first mortgage, in which case it's called a simultaneous second—for example, a first mortgage for 85 percent and a simultaneous second for 15 percent was common during the bubble, meaning the homeowner has no skin in the game and any home price decline puts the second lien underwater.

HELOCs and home equity loans are often lumped together for analytical purposes because they share common risk factors: They are junior not only to first mortgages, but also to accrued interest, foreclosure costs, brokerage commissions, and other expenses in the event of a default. In the current declining home price environment, first mortgages are almost always impaired upon default, meaning HELOCs and home equity loans suffer a total loss—in fact, sometimes even more than 100 percent, since there 's a cost to write off the loan.

HELOCs and home equity loans soared in popularity during the bubble, resulting in $900 billion of total exposure by banks by the end of 2008, as shown in Figures 4.25 and 4.26 '

In addition to $900 billion held by banks, approximately $100 billion each of HELOCs and home equity loans were sent to Wall Street and securitized, for a total exposure of $1.1 trillion.12

Unlike most other types of residential loans, which were sent to the GSEs or Wall Street, banks kept more than 80 percent of HELOCs and home equity loans on the balance sheets, making them especially

Figure 4.25 HELOCs and Home Equity Loans Origination Volume

Source: Inside Mortgage Finance, Inside Mortgage Finance Publications, Inc. Copyright 2009. Reprinted with permission.

Figure 4.25 HELOCs and Home Equity Loans Origination Volume

Source: Inside Mortgage Finance, Inside Mortgage Finance Publications, Inc. Copyright 2009. Reprinted with permission.

$1,000 -| $900 -$800 -$700 -$600 -$500 -$400 -$300 -$200 $100 $0

I Closed-End Junior Lien Mortgages Home Equity Lines of Credit

Figure 4.26 HELOCs and Home Equity Loans Held by Banks

Source: FDIC Quarterly Banking Profile.

vulnerable to losses in this area. For example, as of year-end 2008, after acquiring Wachovia, Wells Fargo had $129.5 billion of HELOCs and home equity loans versus only $45.1 billion of common tangible equity.

Delinquencies, while low, are rising rapidly among HELOCs and home equity loans, as shown in Figure 4.27. As of Q3 08, HELOC delinquencies had reached their highest level on record.13

Figure 4.28 shows home equity loan performance by vintage (note that very few HELOCs were securitized, so this chart is only for second liens).

To give you a sense of how toxic these loans can be, Figure 4.29 is a chart from the presentation Ambac Financial Group released concurrently with its Q1 2008 earnings report, which shows the monthly losses of a second lien pool securitized by Bear Stearns that closed in April 2007. (Note that these are not delinquencies, but actual losses, though they tend to be identical since there 's usually no recovery when a second lien defaults.)

While this is an extreme example of higher-than-average losses due mainly to the 2007 vintage, the rapid implosion of this pool is nevertheless stunning. Ambac projected that the monthly loss rate would peak above

Day Delinquency Rate

Figure 4.27 HELOCs and Home Equity Loans 90+ Day Delinquency Rate

Source: FDIC Quarterly Banking Profile.

cycycycycycycycycycycycycycycycycycycycy

Figure 4.27 HELOCs and Home Equity Loans 90+ Day Delinquency Rate

Source: FDIC Quarterly Banking Profile.

2nd Liens Delinquencies

Months of Seasoning

Figure 4.28 Home Equity Loan 90+ Day Delinquency Rate by Vintage

Source: Amherst Securities, LoanPerformance.

Months of Seasoning

Figure 4.28 Home Equity Loan 90+ Day Delinquency Rate by Vintage

Source: Amherst Securities, LoanPerformance.

Months Since Close —•— Ambac Projection April 2008 —■— Actual--T2 Partners Estimate

Figure 4.29 Monthly Loss Rate of Bear Stearns 2007 Second Lien Pool

Source: Ambac Financial Group Q1 2008 presentation (April 23, 2008); Amherst Securities.

2.5 percent but then quickly decline thereafter—yet still estimated that total losses to the pool would be 81.8 percent! (This was grim news for Ambac, which guaranteed the senior tranche of this pool thinking that losses might be in the 10 to 12 percent range.) With actual data through the end of 2008, one can see that monthly losses did indeed reach the 2.5 percent level—but have remained at that level rather than declining. At this rate, the pool will be wiped out in a total of five years.

Goldman Sachs estimates that losses among HELOCs and home equity loans will be 11 percent.14 Yet again, we think losses are likely to be double this.

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Responses

  • sarama
    Is a h.e.l.o.c. securtitised?
    8 years ago
  • leila
    Is line of credit a junior lien?
    8 years ago
  • tobias
    What is a simultaneous secondlien home equity line of credit?
    8 years ago
  • molly gray
    How are heloc traded on wall street securitization?
    8 years ago
  • Martina
    What percent of helocs were written off?
    8 years ago
  • Macario
    Is a closed end junior lien loan the same as a home equity loan?
    8 years ago
  • SUMMER
    Is a HELOC a junior lien?
    8 years ago
  • steven
    Are helocs securitized?
    8 years ago

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