U.S. regulators are examining whether the nation's home lenders have accurately valued $845 billion of home equity and other second-lien mortgages, according to seven people with direct knowledge of the matter.
The Federal Reserve and the Office of the Comptroller of the Currency have teams checking on default risks at the biggest banks and whether they've set aside enough reserves to cover the loans, according to the people. They spoke on condition of anonymity because the review is continuing and examinations are not public.
Regulators are focusing on individual loans where borrowers are already overdue on their first mortgages, or where the value of the home has dropped below the size of the loans, according to the people. Examiners are requiring banks to conduct a special impairment analysis to determine the risks of steep losses on the loans, even if borrowers are current on payments, said two people with knowledge of the process. Such an analysis may result in a demand for more reserves, they said.
The Fed may use the results of the examination to help evaluate capital planning and future dividends at the largest lenders, one person said. With banks cutting reserves as overall defaults decrease, regulators want to ensure the companies still have enough to cover second liens that go sour, the person said.
"For a regulator, any time there's an asset class that experiences a significant change, there's a concern that there could be a decline in value that hasn't been recognized by every single financial institution," said Moshe Orenbuch, an analyst at Credit Suisse AG.
Second mortgages soared in popularity during the housing bubble as homeowners sought to tap growing equity values. The balance of home equity loans and other second mortgages held by lenders rose from $327.6 billion in 2000 to a peak of $1.14 trillion in 2007, according to Inside Mortgage Finance, a trade publication. The total fell to $845.3 billion in the first quarter of 2011.
Home equity lines of credit made up the largest second-lien category with unpaid balances of $666.5 billion in the first quarter, the data shows.
Investors are skeptical about the true worth of assets held by U.S. lenders, with the KBW Bank Index selling at about 75% of stated book value for the 24 companies represented. Bank of America of Charlotte, N.C., has been pummeled by speculation that it needed a bigger capital cushion to protect against unexpected losses. The stock has lost almost 50% this year and sells for about a third of book value.
B of A, the biggest U.S. lender by assets, holds the largest second-lien portfolio, with $129.3 billion in unpaid balances, according to first-quarter data from Inside Mortgage Finance. Wells Fargo in San Francisco is second with $114.4 billion, and JPMorgan Chase & Co. is third, with $101.6 billion. Citigroup Inc. had $46 billion and PNC Financial Services Group Inc., which is based in Pittsburgh, had $30.1 billion. Spokesmen for the lenders declined to comment on the examination.
John Walsh, the acting comptroller, said in testimony before the Senate Banking Committee last December that examiners were looking into situations where banks had resisted offering loan modifications to distressed homeowners on first mortgages where the bank also held a second mortgage. Modifying the first loan could include an acknowledgement that the home's value had dropped, forcing the lender to take a loss or complete writeoff of the second mortgage.