Sunday, July 06, 2008

More on Banks Reducing HELOCs

by Bill McBride on 7/06/2008 10:20:00 AM

From Mathew Padilla at the O.C. Register: Banks narrow home equity withdrawals A few excerpts:

Several lenders have reduced HELOCs en masse in areas of declining home prices, including Orange County, experts say. ...

[W]idespread HELOC reductions have caught the attention of federal regulators. The Federal Deposit Insurance Corporation on June 26 issued a statement warning lenders that under Regulation Z of the Truth in Lending Act credit reductions must be tied to significant property value declines or if a borrower is unlikely to pay because of a material change in his or her financial situation.
...
Washington Mutual, IndyMac Bancorp, and Countrywide Financial – which was just acquired by Bank of America – have led the industry in cutting HELOCs, according to an April 14 report by investment bank Keefe, Bruyette & Woods (KBW).
...
The report by KBW said there were about $1 trillion worth of unused HELOCs earlier in the year, and $1.2 trillion of used lines and other home equity loans.
...
Frederick Cannon and Brian Kleinhanzl, the report's authors, argue such reductions could backfire on lenders, leading to more loan delinquencies if borrowers needed their credit lines to stay financially afloat.

They said the cuts could worsen a recession ...

[Kerry Vandell, professor of finance, and director of the Center for Real Estate at UCI] disputes those assertions. He says the more equity borrowers have in their home, the more likely they are to keep paying their mortgages. Therefore, reducing HELOCs could help lower foreclosures, because it will prevent home owners from adding more debt against their properties. That's good for the economy, he said.
If homeowners were using their HELOCs to pay their first and second mortgages - or some similar strategy of going deeper and deeper into debt - then cutting the HELOC is good for the bank and the economy. But if the homeowners actually have substantial equity in their homes (like some of the examples Matt gives in the article), then cutting the HELOCs contributes to the credit crunch and is bad for the economy. This is why the FDIC does not want lenders to reduce HELOCs en masse:
The FDIC ... warned banks that ... a shotgun-style approach to freezing HELOCs might violate Truth-in-Lending regulations; under Regulation Z, lenders can reduce an applicable credit limit only in the event of “significant decline” to the value of an individual property (a “material change” in the borrower’s financial condition — such as the loss of a job — qualifies as well).

The FDIC said the Federal Reserve has defined a “significant decline” to mean situations where the unencumbered equity in a property is reduced by 50 percent or more, the FDIC said.