Bank of America Corp., whose home-equity mortgage portfolio exceeds its stock market value,probably will say about $2 billion of junior loans are badassets tomorrow even as some borrowers are still paying on time.
Thats what Barclays Capital estimates the bank will reportin its first-quarter results, following decisions by JPMorganChase & Co., Wells Fargo & Co. (WFC) and Citigroup Inc. (C) to reclassify$4.1 billion of junior liens as nonperforming.
Regulators are pressing for the change on concern thatfalling home prices have wiped out collateral on many secondmortgages, leaving them as unsecured debt. About 20 percent ofthe nations $845 billion of home-equity loans exceed the valueof the properties when combined with primary mortgages,according to CoreLogic Inc., and about 36 percent of Bank ofAmericas were at least partly underwater at the end of lastyear, according to regulatory filings.
The reclassification may change the way the investorslook at the company but as far as the vulnerability it doesnothing to take that away, said Jeffrey Sica, the Morristown,New Jersey-based president of SICA Wealth Management who helpsoversee $1 billion of assets and whos bet on a decline in theshares of Bank of America in the past. This is something theyhave very much tried to keep under wraps.
Bank of America Corp. in Charlotte. Close
Bank of America Corp. in Charlotte.
Close
Bank of America Corp. in Charlotte.
Almost a quarter of homes in the U.S. were worth less thanthe mortgages against them, according to CoreLogic, the datafirm based in Santa Ana, California. About 4.4 million had home-equity mortgages, the firm said.
Stripping Value
Banks have been carrying some high-risk junior mortgages ontheir balance sheets at full value even after a rout in homeprices stripped almost $7 trillion from property values,according to the Federal Reserve and other bank regulators.Executives including Bank of America Chief Executive OfficerBrian T. Moynihan and Wells Fargo CEO John Stumpf have saidborrowers tend to keep paying as long as they are able, even ifhome prices decline.
The risk for lenders is that if the borrower does defaultand the property is auctioned, a junior loan stands behind theprimary mortgage for repayment. Typically, the second-lienholder suffers a total loss.
Investors are trying to find the canary in the coalmine, said Chris Gamaitoni, a mortgage and banking analyst atWashington-based Compass Point Research and Trading LLC. Bankof America is certainly the most worrisome.
Quarterly Report
Bank of America, which has the biggest home-equityportfolio in the U.S., may post a 6.9 percent decline in first-quarter adjusted profit to $1.62 billion tomorrow, according toanalysts surveyed by Bloomberg. The Charlotte, North Carolina-based company had been the nations largest mortgage lenderafter buying Countrywide Financial Corp. and had a portfolio of$136.7 billion in home-equity loans at the end of last year,according to a company filing.
The lender was unchanged at $8.92 at 4:15 p.m. in New Yorktrading. Its gained 60 percent this year boosting the marketcapitalization to about $95.7 billion.
About 22 percent of the banks home-equity loans wereactually senior liens at the end of last year, according to acompany filing. That compares with about 28 percent at New York-based JPMorgan (JPM) and 20 percent at San Francisco-based WellsFargo. The figures at all three banks exclude impaired loanspicked up in acquisitions.
Potential Impact
Bank of America has identified $4.7 billion of home-equityloans that stand behind a delinquent first, according to a year-end filing, and the total reclassified as nonperformers may behigher than Barclayss estimate, according to Brian Foran, a NewYork-based analyst at Nomura Holdings Inc. Citigroup moved about2 percent of its home-equity portfolio, the smallest of the fourlenders. At that rate, Bank of America would reclassify about$2.73 billion.
I would expect BofA to be in the same ballpark and maybeslightly higher, Foran said. Given that they had identifiedand disclosed these loans ahead of time my guess is they will dothe same as the others. The only question mark hanging over thisissue: is it the last step, or the first step?
The three companies collectively hold 40 percent of thenations home-equity loans, according to Fitch Ratings. WellsFargo, the biggest U.S. mortgage lender, and JPMorgan, thebiggest bank by assets, had already set aside reserves for theloans they reclassified as nonperforming, so there was no impacton reported profit, the banks said last week.
Still, the changes at the two banks surprised and spookedinvestors, despite not having an earnings impact, wroteBarclays analysts led by Jason Goldberg in a research note.
No Teeth
The Feds directive, which reiterated rules in force sinceat least 2006, isnt enough to mitigate the risk junior loanspose to the banking system, said Rebel Cole, a former FederalReserve economist and now a finance professor at DePaulUniversity in Chicago.
The guidance has absolutely no teeth, Cole said. Theregulators could simply say, We know at least 25 percent offirst mortgages are under water, therefore, at least 25 percentof your second liens are uncollateralized and have to beclassified as substandard or doubtful.
The risk of home-equity loan defaults will increase if realestate prices continue to decline, analysts and economists said.Home values have tumbled by a third since reaching a peak inmid-2006, according to the S&P/Case-Shiller home price index.Diane Swonk, chief economist of Mesirow Financial Inc. inChicago, estimates home prices will retreat another 3.9 percentthis year, which would strip $706 billion from home values.
Default Rates
Fitch estimates 20 of the largest U.S. banks, includingunits owned by foreign lenders, may face another $110 billion injunior-loan losses under a stressed scenario, according to aFeb. 27 report that cited third-quarter 2011 figures. Bank ofAmerica leads the group with $29.1 billion in potential losses,Fitch said.
While equity loans carry a higher risk if they default,delinquencies are lower. In the fourth quarter, 4.08 percent ofhome-equity loans were missing payments, according to theAmerican Bankers Association in Washington. That compares with7.58 percent for first-lien mortgages, according to the MortgageBankers Association in Washington.
Some of the difference is because of the way banks booksecond liens. Non-performing home-equity loans typically arewritten off in six months. That compares to an average two-yearperiod from delinquency to a foreclosure sale on a primarymortgage. Also, home-equity payments are smaller, meaninghomeowners are likely to keep paying after a default on theirprimary mortgage -- at least for awhile.
Pretty Obvious
When we analyzed it, it was pretty obvious it was just atiming difference, JPMorgan CEO Jamie Dimon said. In almostall cases when the first went delinquent, the second eventuallywent delinquent. And in all cases where the first went intoforeclosure, the second was a loss, basically a total loss.
Jerry Dubrowski, a Bank of America spokesman, declined tocomment, as did Wells Fargos Mary Eshet and Citigroups Mark Rodgers. Amy Bonitatibus, a JPMorgan spokeswoman, declined tocomment beyond Dimons remarks.
Were seeing the lingering effects of the housing marketbust, Swonk said in an interview. Guidance from regulatorsis the reality of making sure banks are sound and secure whilewe work through the ripple effects of the financial crisis.
To contact the reporters on this story:Kathleen M. Howley in Boston at kmhowley@bloomberg.net;Dakin Campbell in New York at dcampbell27@bloomberg.net.
To contact the editor responsible for this story:Rob Urban at robprag@bloomberg.net
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