Banks Using Leverage to Force Home Equity Repayments

Includes: BAC, IDMCQ, NCC, WFC
by: Michael Steinberg

The Wall Street Journal's (3/6/08) "Some Borrowers Hit New Snag In Refinancing" discusses efforts by Bank of America (NYSE:BAC), IndyMac (IMB), National City (NCC) and Wells Fargo (NYSE:WFC) to hold first mortgage refinancing hostage to their home equity loans and lines of credit. Their second lien position would move to first unless they subordinate to the new first mortgage. The banks are using their leverage to force borrowers to either repay their home equity loans and lines, or reduce the existing lines.

The WSJ gives examples of banks refusing to subordinate for borrowers with strong credit to refinance. The borrowers would get a new first mortgage with a lower interest rate and monthly payment, leaving more money available to pay the home equity loan. You would think that the banks would enthusiastically embrace this. But, it is more important for the banks to reduce their exposure to second liens. When home equity line of credit [HELOC] securitizations reach a certain delinquency level, banks are no longer reimbursed for HELOC advances to borrowers.

Previously, in "Power of 2nd Place", I spoke about banks using second liens to block short sales. (Short sales allow the property to be sold at less than the mortgage balance.) The first mortgage holder must negotiate compensation for the second lien holder in order to proceed and grant the new buyer a clean title. The same would be true in a "short" refinancing.

Home equity products differ from first mortgages in that they generally have recourse beyond the property. While it is often not practical to foreclosure on a home equity loan, the banks can pursue other assets. Just because banks have written second mortgages down to zero doesn't mean they cannot extract value from them.

Disclosure: Author is long BAC, IMB, NCC and WFC.