HELOC lenders are beginning to limit or freeze HELOC credit lines, according to analysts.
HELOCs were defined by Credit Suisse analysts as a revolving credit generally made to prime borrowers that are in a second lien position on the property. HELOCs, which float monthly off an index that is typically the prime rate, have a draw period that is usually five to 15 years wherein the borrower pays only interest on the drawn amount. This is followed by a 10 to 20 year repayment period or a balloon payment, Credit Suisse analysts explained. The utilization rate is a measure of the amount drawn by the borrower divided by the HELOC credit line amount.
There have been recent examples of banks that have stopped lending on these lines. Countrywide Financial Corp., for instance, announced earlier this year that it was reducing or freezing the credit
lines of 122,000 borrowers. Similarly, JPMorgan Chase, Bank of America and Wells Fargo have decided to also freeze lines of credit, although these banks have not released the numbers of borrowers who will be affected by this move.
Roelof Slump, a managing director at Fitch Ratings, said that because of the declining home prices and higher borrower delinquencies, many banks who serve as creditors to HELOC borrowers with higher CLTVs (combined loan-to-value ratios) or LTVs have limited these borrowers' ability to extract further from their lines of credit.
"Banks don't want to see higher risk on their balance sheets," Slump said. "These banks, who are the investors in these loans, usually have the ability to notify the borrower about their inability to access more credit from their HELOCs."
Slump said that generally speaking, a lot of HELOC transactions were kept by the banks because they were a good match in terms of asset and liabilities as they have a direct relationship to Fed funds. Borrowings are on a short-term basis, as the asset amortizes, which matches the short-term nature of the Index.
"It provides a natural hedge for interest rate risk, so the problems are arising purely on the credit side," Slump said. He said that this worked well when first lien HELOCs were originated to better borrowers in better quality areas, and/or in instances where the borrowers had relatively low LTVs. "Now given that house prices are falling, there might be some degree of adverse selection going on."
According to Slump, second lien HELOCs and closed end second lien loans have shown abject performance, specifically the 2007 and 2006 vintage originations, considering that these mortgages frequently have 90% to 95% CLTVs. Additionally, when these second liens default, there's usually little or no recovery.
By contrast, HELOCs that have first lien position usually have better recovery levels. "If the LTV goes from 75% to 95%, this does not mean you'll have a full loss on that first lien, as there should be an amount to recover when that property is foreclosed upon, and so the loss severity might not be as high," Slump said. "However, the percentage of recovery on second liens is generally poor."
In a recent presentation, Credit Suisse analysts mentioned what their 2006 vintage securitized HELOC loss projections are. The results of their analysis show that cumulative losses as a percentage of the original balance of the loan range from 7% to 57%, with a 34% average. Meanwhile, the firm said that the projected future losses as a percentage of the current loan balance range from 8% to 76%, with a 49% average.
According to Credit Suisse analysts, the fact that some deals fail their rapid amortization trigger gives issuers more incentive to freeze HELOC lines. "In a rapid amortization event, the issuer needs to fund all additional draws," Wen Zhang, vice president at Credit Suisse explains. "So if a transaction hits rapid am, there's more incentive to cut the lines compared with during the managed am period where issuers typically don't need to fund the draws unless the draws exceed the principal payments collected."
The rapid amortization period starts when the managed amortization period (MAP) ends. MAP represents the time from the transaction's closing date to the earlier 60th payment date or when the rapid amortization event happens.
Credit Suisse analysts said that it could happen that a transaction enters into a rapid amortization period and not trigger a rapid amortization event, but they stated that a rapid amortization event is different for every deal. According to Credit Suisse, in a majority of the wrapped HELOC deals, this event is tied to either the total amount drawn on the policy, when a draw on the policy happens or the duration in which monoline draws stay unpaid for.
Analysts added that some transactions, mostly senior/sub ones, have performance-based rapid amortization triggers such as cumulative losses. They noted that there are a few HELOCs that do not define a rapid amortization event in the deal documents.
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