Mounting losses in home equity loans and lines of credit have officials at the Office of the Comptroller of the Currency taking notice, with OCC chief John Dugan warning yesterday that banks need to build reserves for losses in the area and suggesting that many need to “return to the stronger underwriting standards of past years.” The call for tighter underwriting standards from OCC officials would seem to contrast pretty sharply with the relaxing of underwriting standards now quickly taking place at Fannie Mae (FNM) and Freddie Mac (FRE), both of whom this week nixed long standing so-called declining market policies in the face of consumer criticism. Home equity loans and lines of credit grew dramatically in recent years, more than doubling to $1.1 trillion in originations since 2002. In part, Dugan suggested, growth in second liens was tied to rapid appreciation in house prices, the tax deductibility feature of home equity loans, and low interest rates. “But another contributing factor was perhaps not so obvious: liberalized underwriting standards,” he said Thursday afternoon in a speech to the Financial Services Roundtable’s Housing Policy Council. “These relaxed standards helped more people to qualify for loans, and more people to qualify for significantly larger loans.” As the housing bust has rolled on, losses in second liens have begun to pile up. While losses on HEL/HELOCs have traditionally run at about 20 basis points, or two tenths of a percent of loans, they shot up to nearly 1 percent in the fourth quarter of 2007, and to 1.73 percent in the first three months of 2008, the OCC said. Losses on all home equity loans, including HELOCs and junior home equity liens, rose from $273 million in the first quarter of 2007 to almost $2.4 billion in the first three months of 2008 – a nine-fold increase. Not surprisingly, some of the nation’s largest lenders are now suggesting that losses could continue to skyrocket; Bank of America Corp.’s (BAC) recent guidance here is one such example. Obviously, building appropriate reserves will be critical to weathering the storm, Dugan said; the OCC head suggested that examiners will be focusing in on this area going forward. “At some banks, the portion of reserves attributable to home equity loans just barely covers 2007 chargeoffs,” he said. “With losses accelerating, those reserves are simply not going to be adequate, and that’s why our examiners are encouraging more robust portfolio analysis and loss reserve levels.” That, along with more sane underwriting, Dugan said, will be the key to keeping the HELOC problem from spiraling out of control. For more information, visit http://www.occ.gov. Disclosure: The author held no positions in any of the publicly-traded firms mentioned in this story when it was originally published. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

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