Garnet Capital Advisors Blog

The Federal Reserve Bank of New York reported data recently that shows mortgage balances and home equity lines of credit (HELOCs) are heading in separate directions, and have been for some time. Mortgage balances are rising. Mortgages balances recorded as part of consumer credit reports climbed 2.6% in the second quarter of 2016 over the year-prior level. HELOCs, on the other hand, are headed down. They declined 4.2% in the second quarter of the year over the level recorded in the second quarter of 2015.


HELOC balances declined in the second quarter, while Mortgage balances rose .

Mortgages Driven by Low Interest Rates
The New York Fed's Quarterly Report on Household Debt and Credit for August 2016 pegs total mortgage debt at $8.36 trillion in the second quarter. The 2.6% rise in the quarter over the second quarter of 2015 was likely due to new mortgage originations, which stood at $427 billion in the second quarter, an increase over first quarter levels.

The rise in originations was driven by dropping interest rates. The interest rate level, in turn, was spurred in turn by the lower than expected GDP reported for the second quarter. The GDP figure, at 1.2%, was less than half the 2.6% gain analysts were expecting. The interest rate in early August stood at 3.65% for a 30-year fixed-rate mortgage (with a conforming loan balance, considered $417,000 or under), a 48-basis-point decline over the last year.

The relatively low rates drove an increase in new mortgage applications. In early August, new home mortgage applications were nearly 13% above year-ago levels. Mortgage refinancing was also strong in early August, climbing 10% week over week.

Mortgage balances are not only rising, they have been doing so over the long term - for 11 consecutive quarters. During the 11 quarters, mortgage debt has risen 5.9% overall. It is still 10% under the peak registered before the Recession, however.

HELOCs Face Increased Delinquencies
HELOC balances totaled $478 billion in the second quarter according to the New York Fed's report, a decline of $7 billion.

The decline of HELOCs is also a long-term trend - and it's longer than that of mortgage balances. HELOCs have been headed downward for 26 straight quarters. During that six and one-half year period, HELOC totals have fallen nearly one-third, by 32.3%.


The decline in HELOCs has occurred for 26 consecutive quarters.

HELOCs are dropping for a several reasons. Many HELOCs originated by lenders during the housing bubble are coming to the 10-year end of draw. Now that they are in the repayment period, additional draws are precluded, balances are decreasing due to amortization, refinance into lower rate first mortgages and defaults. Not every borrower can absorb the resulting higher interest rates or increased principal amortization. As a result, some borrowers on these HELOCs are becoming delinquent on their payments. A certain proportion of these are entering serious delinquency, at 90 or more days past due. With that, delinquencies and defaults for HELOCs are rising.

According to the New York Fed, the second quarter serious delinquency rates for HELOCs were at 2.0%, while the rates for mortgages stood at 1.8%.

Like the amounts, though, the delinquency rates for mortgages and HELOCs are headed in opposite directions. The mortgage delinquency rate for the second quarter was an improvement over the 2.1% level registered in the first quarter of the year. Delinquency rates for mortgages have also fallen over the past 5 years.

Michael Neal, the Senior Economist with the National Association of Home Builders (NAHB) acknowledged that the 2.0% delinquency rate for HELOCs and 1.8% rate for mortgages is "not that great of a difference, but if you compare it to what it was pre-boom, you'll see it's not what we're accustomed to."

Banks are seeing these trends and becoming increasingly wary about HELOC lending. As Neal observes, "ultimately balances that are seriously delinquent have a high likelihood of entering default," which means that banks may become "shy about originating more of them."

Therefore, despite the fact that mortgage conditions, originations, and balances are fairly robust, HELOCs aren't.

Divergence in the HELOC Trend Between Big Banks and Smaller Banks
The total data reported by the New York Fed masks an interesting development in the overall decline of HELOCs. HELOC totals are falling at the nation's 20 largest banks, in line with the New York Fed's report. However, in an end-of-year 2015 analysis for the NAHB, Neal observed that the outstanding amount of HELOCs held at banks outside the top 20 had actually risen slightly.

The reason is a divergence between the amount of HELOCs at the big banks and smaller banks during the financial crisis. Near the beginning of the twenty-first century, in 2001, the balances of HELOCs were fairly equal between the 20 biggest U.S. banks and all other banks. In 2003, however, their trends began to diverge. HELOCs at the big banks started to rise steeply. HELOC balances at the smaller banks began to drop. At the height for HELOC balances, in 2009, big banks held $475.9 billion in HELOCs.

However, subsequent to the financial crisis, big banks began to sharply pare back their exposure to HELOCs. Six years after the 2009 peak, they held just $315 billion in HELOCs, a drop of more than $160 billion.

Total HELOCs at the smaller banks, by contrast, were fairly free of fluctuation during the 2009-2015 period. HELOC balances at all other banks were $163.3 billion last year. And these portfolios seem to be performing well.

Ultimately, what began as a divergence between big banks and all the others 13 years ago is becoming a convergence. As Neal puts it, "Since the outstanding amount of HELOCs on the balance sheets of all other banks is rising while declining at the Top 20 banks, then the gap between the two cohorts is converging."

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