Home-equity loans are big problems

Wells Fargo & Co., for example, expects its profit in the fourth quarter to be dented by $1.4 billion because of tainted credit in its home-equity portfolio. The San Francisco-based bank cordoned off $11.9 billion in loans from its $83.4 billion home-equity portfolio into a liquidation fund expected to sell at a $1 billion loss. Wells Fargo blamed the deterioration on loans issued indirectly through brokers and other banks.

“Quite frankly, and let me make myself very clear, we took too much layered risk at the indirect channel,” Wells Fargo Chairman Dick Kovacevich said this month at the Goldman Sachs Financial Services Conference. “It was a mistake and we should have known better.” The underwriters for indirect loans tend to be sloppier, according to a Citi Investment Research report, and brokered home-equity loans are “the weakest link” in the mortgage chain.

Banks wrote off 0.48 percent of their home-equity loans in the third quarter, more than double the rate at the beginning of the year, according to Citi. Citi said Countrywide Financial Corp., Key Corp., National City Corp., Washington Mutual Inc., Wells Fargo, Fifth Third Bancorp, SunTrust Banks Inc., and JPMorgan Chase & Co. appear to be the banks with the most dangerous exposure to home-equity credit. A Fifth Third spokeswoman said the company doesn’t comment on analyst reports or opinions.

Home-equity credit is distinct from regular mortgage credit in part because of what bankers call “severity” rather than “frequency.” In mortgage lending, one of the most important reflections of credit quality is usually the delinquency rate. In home-equity credit, though, the defining factor is that while fewer borrowers default, a bank loses more when they do.