FDIC Warns Banks on HELOC Freezes, REO Management

A series of letters sent this week to banks by the Federal Deposit Insurance Corp. served to warn mortgage bankers on HELOCs and REO management practices, as many are increasingly looking to freeze home equity lines and find ways to reduce carry cost associated with growing inventories of bank-owned real estate. The deep freeze hitting many HELOC borrowers became front-page material Tuesday, with a story in the Wall Street Journal covering how lenders are increasingly freezing lines of credit as homeowners see their equity drained at a record pace. The Journal story suggested that banks are moving to freeze HELOCs globally, and then evaluating available credit later on a case-by-case, property-by-property basis — sort of a shoot first, ask questions later approach to managing risk that has left an increasing number of homeowners out in the cold as they contest banks’ decisions to reel in their available credit. The FDIC letter warned banks that such 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. “It’s pretty clear that banking regulators are warning insured banks against taking global actions to restrict credit without having done their due diligence up front,” said one source, a banking executive that asked not to be named in this story. “Don’t cut corners is the message here.” The FDIC said it issued the letter to “remind FDIC-supervised financial institutions that if, for risk management purposes, they decide to reduce or suspend home equity lines of credit, certain legal requirements designed to protect consumers must be followed.” REO management becomes an issue of safety and soundness FDIC officials also issued a warning Tuesday regarding the management of bank-owned real estate, commonly called REO by market participants — but traditionally known as ORE, or other real estate, in reference to the relevant line item on a bank’s balance sheet. In a letter to insured commercial and savings banks, the FDIC said it wanted to “remind bank management of the importance of developing and implementing policies and procedures for acquiring, holding, and disposing of other real estate.” The letter comes as HW’s sources have suggested that some banks are desperately looking for ways to cut a “rising flood of loss severity” tied to bank-owned real estate. Proof of increasing problems tied to real-estate owned came in a separate report released Tuesday by Fitch Ratings, which noted the increasingly negative effect REO is having on investor returns. Our sources suggest that some banks are choosing not to pay taxes on certain low-value REO properties in hard-hit neighborhoods, in the hopes that local municipalities will take the property to a tax sale rather than force the lender to carry the property on its books. The FDIC reminded banks that doing so would violate existing bank safety and soundness guidelines; so too, would failing to review existing hazard and liability coverage to ensure that coverage is sufficient to cover the number of existing assets in an REO portfolio. The FDIC also took aim at accounting issues surrounding REO, as banks look to manage the growing losses associated with the sale of distressed real estate; most banks don’t have to recognize a loss until a property is sold. In particular, banks cannot substitute the value received in a resale transaction involving REO for the fair value of the asset estimated at the time of foreclosure in an effort to make losses more palatable; doing so is only allowed in situations where the REO property is “sold shortly after it is received in a foreclosure,” the FDIC noted. “Give the FDIC some credit,” said a source that spoke with HW. “They’re trying to get in front of the REO mess that’s just gaining steam. “You just have to wonder if any banks have already played some of the games in question here, or what might else have prompted a formal ‘reminder.'”