Three years after Texas lifted a 150-year-old ban on home equity loans, the state's community banks are largely unwilling to make them.

Though small banks nationwide continue to increase their share of the $750 billion home equity market, Texas banks have stayed conspicuously on the sidelines because the 1998 law permitting such loans includes a clause making them especially risky for lenders. Of the top 150 bank home equity lenders in the country, not one is from Texas, according to a recent American Banker ranking. "We don't feel that we can safely do it," said Bill Meacham, chief executive officer of the $119 million-asset Citizens National Bank of Milam County in Cameron. "There are a number of issues that haven't been clarified to our satisfaction, and until that happens, we'd rather let someone else be the test case."

The law imposes penalties - which industry officials call draconian - for even minor or unintentional mistakes in loan documents. Such mistakes could result in forfeiture of a loan's principal and interest, though no lender has yet been forced to forfeit a loan.

The vast majority of companies making home equity loans in Texas are out-of-state banks and finance companies that are "big enough to absorb the risk," said Ann Graham, chief counsel and vice president of the Texas Bankers Association.

"Ours is absolutely the most restrictive home equity framework in the whole country," said Ms. Graham. A few community banks are making the loans, she said, "but not on a widely marketed or systematic basis."

Al Alsop, a Houston attorney who represents several mortgage lenders, said the home equity restrictions are rooted in Texas' longstanding tradition of protecting homeowners.

In 1998 the state constitution was amended to allow home equity lending. However, Mr. Alsop said, the law included an "ambiguously worded" forfeiture clause that applies if any of its more than 25 conditions restricting home equity lending are violated. And a few borrowers are using the forfeiture clause to argue that errors have invalidated the liens placed on their homes when their loans were closed.

Orange, Calif.-based Ameriquest Mortgage Co. is now being sued by a Texas borrower seeking to have a lien invalidated because of errors discovered in loan documents. If the suit succeeds, Ameriquest would have no way to recover the loan's principal, not to mention its interest, under the law.

Unless such cases are resolved favorably in the courts, or the state Legislature acts to clarify the law, most Texas community bankers say they will stay away from making such loans.

Dianne Hughes, executive vice president of the Texas Mortgage Bankers Association, said her group is lobbying the Legislature to amend the constitution to assure that home equity lenders will, at a minimum, be entitled to get their principal back if a mistake is discovered. But in a session dominated by redistricting concerns, even that might not be achieved, she said.

Hyman Sauer, president and chief executive officer of the $36 million-asset First National Bank of Eldorado, said that Texas was the last state in the country to permit home equity lending and, by 1998, bankers were willing to make any compromise just to get a law on the books. Still, he said, "We all hated the bill. It was horrible for bankers."

For example, the law caps loans at 80% of a home's value, forbids home equity lines of credit, and requires a 12-day wait before a deal can become final and borrowers get their money.

But what worries them most is a clause that puts lenders at risk of losing their principal and interest if they make any mistake in the loan documents.

"What has kept community bankers on the sidelines is that question of forfeiture," said Mr. Alsop, the Houston lawyer. "It's the complexity of satisfying all those conditions and the threat of loss if you don't."

Manuel J. Mehos, chief executive officer of $3 billion-asset Coastal Bancorp in Houston, said that despite the risks his company makes home equity loans.

"We're just very careful about it," he said. "Even though there is always that chance you could slip up, if you have good controls you can avoid having any problems. Community banks are a little more worried about it because they don't have the resources. It's just not worth it to them."

Home equity lending is growing rapidly nationwide, according to George Yasick, vice president of SMR Research in Hackettstown, N.J. He estimated that home equity lenders originated loans totaling $368 billion last year, a 25% increase from the year before, and he predicted 20% growth this year. Last year he said, was the first in which banks originated as many loans as the nonbank subprime lenders that have dominated home equity lending.

Some observers take a dim view of home equity lending, no matter what the legal circumstances. Arthur Wilmarth, a George Washington University Law School professor who specializes in banking issues, said increasing levels of consumer debt could create a serious problem for many banks. Borrowers who take out a home equity loan to pay off old debts, he said, could continue to pile up new ones afterward.

"It's a potential nightmare," Mr. Wilmarth said. "You've just got to pray that some of these borrowers don't lose their jobs."

Mr. Sauer of First National of Eldorado also acknowledged reservations about home equity lending.

In 1998, he recalled, "we started taking applications, but the first two or three people to apply had run up a lot of credit card debt. I got cold feet. They just didn't have the kind of credit histories we were hoping for."

Three years later, First National still has made no home equity loans. But despite his doubts, Mr. Sauer said, he would still like the chance to try.

"I'd love to, but it's got to be a two-way street," he said. "Right now I feel like everything is against us."

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