At 15% to 50% of Tier 1, Underwater Home Equity Stirs Unease

Delinquencies have stabilized and chargeoffs have eased, and the second dip in home prices has not been remotely as severe as its older twin.

Nonetheless, enormous pools of home equity loans that in fact have little or no home equity standing behind them continue to sow doubts about the health of the nation's largest banking companies.

The portfolios can look like gaping cavities in balance sheets. At March 31, home equity loans to underwater borrowers — or those who owe more on their first and second liens combined than their homes are worth — were equivalent to about half of Tier 1 common equity at Wells Fargo & Co. and about a third at Bank of America Corp. (see chart).

Most of these are performing, however. Fewer than 5% of Wells Fargo's roughly $40 billion of underwater home equity accounts were late by two or more payments. B of A's roughly $40 billion of underwater second-lien mortgages compared with about $2.6 billion in total nonperforming home equity loans, excluding impaired assets it acquired as a part of its purchase of Countrywide Financial Corp.

Moreover, the undertow from falling home prices has weakened substantially, and lenders by now do have something of a track record for the behavior of such portfolios.

In a presentation in February, JPMorgan Chase & Co. estimated that the amount of balances in its home equity book plunging underwater declined from $15 billion in 2008, when home values were in free fall, to just $1.3 billion last year. The company projected lifetime losses of 12% to 15% on its nearly $20 billion pool of second liens with loan-to-value ratios of more than 100%. (The figures excluded impaired loans it picked up in its acquisition of the banking operations of Washington Mutual Inc.)

Still, the underwater portfolios appear to be profoundly unstable. Researchers have concluded that negative equity is a chief determinant of default, and analysts question whether large proportions of borrowers are skating by on minimum home equity payments and precarious modifications to first liens.

In Wells Fargo's earnings presentation last month, Chief Executive John Stumpf said he "couldn't be happier" with the trajectory of the company's overall mortgage portfolio, which has experienced lower delinquencies than at large competitors. But, he added, "Now if we have a double dip, if we have another whole thing that I don't expect, all bets are off."

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