Home equity loans were part and parcel of the mortgage bubble, and the bust has transformed them into one of the most significant loose ends in a crisis that still appears far from resolution.
Whatever their ultimate fate, most of the action is playing out on bank balance sheets.
Portfolio loans at banks and thrifts represented 75% or more of total outstanding home equity credit for most of the last decade, according to data from the Federal Reserve and the Federal Deposit Insurance Corp. (see charts). The share packaged into securities peaked at a little more than 8% in the first quarter of 2007, and lending by credit unions and finance companies accounted for the rest.
"Piggyback" loans — or second liens underwritten simultaneously with first liens — were standard substitutes for substantial down payments and mortgage insurance in subprime and alternative-A lending, and the data suggests that bank balance sheets were a principal source for such borrowing.
Bank closed-end second liens more than doubled from 2004 to about $233 billion in 2006, surpassing a roughly 60% increase in total nonbank home equity loans to about $274 billion.
Growth in bank home equity lines of credit was relatively tame at about 14% over the same period to $559 billion. However, bank home equity lines of credit kept growing through the first quarter of 2009 — more than a year after banks began slashing unused lines and more than a year after closed-end second liens peaked — perhaps reflecting a move by squeezed households to tap funds where they could during the severest phase of the recession.
Among banks, home equity lending also became more concentrated among the giants in the market. The share held by subsidiaries of the nation's four largest banking companies rose 17 percentage points from 2004, to about 42% last year, an increase helped by a series of acquisitions in 2008: Bank of America Corp.'s purchase of Countrywide Financial Corp., Wells Fargo & Co.'s purchase of Wachovia Corp. and JPMorgan Chase & Co.'s purchase of the banking operations of Washington Mutual Inc.
Citigroup Inc. holds a relatively small share of the revolving home equity loan market among the big four, but heavily ramped up its closed-end second lien business in the middle of the last decade and ranked behind only B of A in that sector last year.
But while enormous fractions of troubled borrowers have second liens, the issue for banks is more directly the proportions of their home equity portfolios that are at risk.
Bankers have insisted that the typical home equity borrower is affluent, and regulators have supplied reassuring statistics. In December, the Office of the Comptroller of the Currency said that it had estimated that 6% of national bank second liens were current and performing but behind delinquent or modified first liens.
Also, banks have been burning off significant amounts of home equity loans through chargeoff for some time — about $75 billion in all from 2008 through 2010.
Further, while securitization was always a relatively modest source of funds for the market, a roughly $65 billion decline in home equity-backed bonds since their peak also suggests that large pools of weak assets have already been flushed out of the system.
(To be sure, these securities have caused pain for the banking industry. B of A said that it had reserved about $1 billion for second-lien buybacks as of the end of last year, funds that were used as a part of the settlement with the bond insurer Assured Guaranty Ltd. that it announced in April.)
Still, with huge portfolios already stripped of collateral by the crash in home values, and with home prices falling once again, the extent of the damage that remains to be absorbed is unclear.