Joshua Lott/ReutersA Realtor and bank-owned sign near a house for sale in Phoenix in 2011.A little more light is being shed on a type of loan that has been stinking up bank balance sheets.
In first-quarter earnings reports on Friday, Wells Fargo and JPMorgan Chase said a recent move by bank regulators had led them to increase their totals for at-risk junior-lien mortgages. These are the loans that homeowners have taken out in addition to their first, or main, mortgage on their house. Wells Fargo had $83 billion of junior-lien mortgages at the end of March, while JPMorgan had $98 billion of home-equity loans, another term that is often used for junior-lien mortgages.
If a homeowner defaults on the first mortgage, the second mortgage should in theory experience big losses, as it has a lower claim on the underlying asset, the foreclosed house. But some observers suspect that banks have been freeloading — on actions by the first mortgage holders — to avoid losses on their junior mortgages.
This is how freeloading may occur.
A homeowner’s first mortgage has been sold off and stuffed into mortgage-backed security. Later, as part of efforts to alleviate the homeowner’s debt burden, the first mortgage gets its principal or interest rate reduced. The owner of the mortgage-backed security would have to bear the cost of that. If this borrower also had a junior-lien mortgage with a bank, there’s a good chance that the adjustment to the first mortgage will make it easier for the borrower to pay the junior loan.
Legally speaking, however, the junior mortgage should be the first debt on the house to take the hit – not the first mortgage. The concern is that losses on junior mortgages are artificially suppressed, and could spike higher if, for instance, holders of mortgage-backed securities legally blocked write-downs of first mortgages.
Enter the bank regulators.
In January, they said that banks had to do more to reflect the status of junior-lien mortgages, where the borrowers also have at-risk first mortgages. In response, Wells and JPMorgan decided to adjust their bad-loan totals to also include junior mortgages that are current but come behind past-due first mortgages.
Wells said it added $1.7 billion of “performing” junior mortgages to its total of non-performing loans. That addition drove an 80 percent jump in its non-performing junior mortgage total, helping take it up to $3.6 billion at the end of March from $2 billion at the end of December.
In the first quarter, JPMorgan added $1.4 billion of performing junior mortgages to its non-performing loans and $200 million of past-due ones. That led to a 115 percent jump in non-performing junior mortgages in the first quarter.
From one perspective, the banks’ numbers suggest there isn’t too much freeloading. For instance, JPMorgan’s $1.4 billion increase is quite a small percentage of the $98 billion it has in home-equity loans.
Still, if all that $1.4 billion ended up as a loss, it would be a substantial hit for the bank. So it’s important that it was flagged to outsiders.
Questions remain, however.
One is how banks go about quantifying how many borrowers who have past-due first mortgages also have junior mortgages. Banks should easily be able to find out if a first mortgage is past-due if they hold it on their own books, or if they collect payments on mortgages that ended up backing securities. It is harder to track first mortgages that they don’t hold or don’t collect payments for.
Banks have to make educated guesses about how many of those are past due. And that category of first mortgage isn’t small. At Wells, 40 percent of its junior mortgages come behind first mortgages that the bank doesn’t hold or collect payments on.