OCC warns of rising HELOC risks
A significant amount of home equity lines of credit will reach the end of their draw period beginning in 2014, about the same time the Federal Reserve plans to end its downward pressure on interest rates.
The Office of the Comptroller of the Currency released its first semiannual report on threats it sees to the banking sector. Included are still elevated levels of foreclosures, loosening underwriting standards and a wave of new products these firms are beginning to venture into.
But past loans could still raise major problems as well.
In 2012, roughly $11 billion in HELOCs reached the end-of-draw period, marking the moment when a borrower can no longer draw equity from their home and must begin paying back the principal plus interest.
By 2014, this number grows to $29 billion, nearly doubles in 2015 to $53 billion and could reach $111 billion by 2018, according to the OCC.
"Generally, the term of the home equity contract including both the draw period and full amortization is 30 years although numerous other types of structures are prevalent including those with a draw period and a balloon payment," the OCC said.
Banks most often offer a HELOC to borrowers, charging the prime rate plus a determined margin.
The Federal Reserve sets the prime rate, and for the past several years has kept it low in an effort to stimulate a still weakened economy. But the Fed said in its latest committee hearing that it plans to keep interest rates low only through the end of 2014, precisely the time when many HELOC borrowers will begin paying lenders back.
The Fed usually raises the rate in incremements, but the pain can still come quickly. Beginning in 2004, it raised the rate 25 basis points 20 times in a row, pushing prime to 8.25% from 4% before reversing course post-crisis.
More of these loans are already falling into trouble. The delinquency rate on HELOCs increased to 1.78% in the first quarter from 1.69% at the end of last year, according to the American Bankers Association.
"It will be many quarters before delinquencies on home equity loans get back to anything close to normal," said ABA Chief Economist James Chessen.
The OCC said because home prices in many areas are still slow to recover since these loans were originated, many borrowers will struggle to refinance. This translates to heightened risk for banks still trying to untangle their balance sheets from the latest housing bust.
"Approximately 58% of all HELOC balances are due to start amortizing between 2014 and 2017," the OCC said. "Housing price declines have led to questions for the banking industry about carrying values and allowance levels that support home equity portfolios."