markets-hub.com

Home equity lines of credit will be the next chapter in the ongoing credit deterioration saga, and specialty finance and regional banks are going to bear the brunt of HELOC risk, Goldman Sachs said.

The warning came in a research note that was relatively upbeat on other financial sector stocks—analyst Richard Ramsden upgraded some brokers and asset managers and said fears about established names such as Lehman Brothers were exaggerated.

“Within mortgage, home equity is taking the lead as the biggest near-term problem,” he wrote Tuesday. Ramsden lowered estimates at most banks and downgraded mortgage bankers including Wells Fargo, Marshall & Isley and Zion Bancorp. He predicted median earnings-per-share growth for the sector in 2008 will dip 4% versus 2007.

Losses in the $1.1 trillion home equity market are entering uncharted territory, he said.

“We now forecast that the 2006 vintage of home equity will have 3.3% cumulative losses, and the 2007 vintage will have 11.1% losses … For the 2007 vintage, these loans will have credit card-like cumulative loss rates with mortgage-like yields – clearly a losing combination.”

Annual losses will rise to 1.75% in 2008 from 0.41% in 2007, 0.16% in 2006 and 0.1% in 2005, he estimated.

Only a very small percentage of HELOCs have been securitized, he pointed out, which leaves “a significant percentage of the risk on bank balance sheets.” Ramsden sees total home equity-related credit losses ahead of $52 billion.

HELOC delinquencies are already soaring—according to BMO Capital Markets analysts Peter Winter and Lana Chan, delinquencies increased 17% sequentially and 59.9% year-over-year at the last quarter. Citing American Bankers’ Association figures, Winter and Chan noted that delinquent consumer accounts in the fourth quarter reached a level—2.56%—not seen since 1992, when it was 2.68%.

“We believe that it is still too early to start buying bank stocks as we expect another shoe to drop on bank earnings from rising credit costs and further margin pressure,” they wrote in a note to clients Tuesday. “[L]oans that were poorly underwritten over the last few years do not all of a sudden become good loans just because the Fed is cutting rates,” they said.

Richard Bernstein at Merrill Lynch echoed that caution on banks and warned that apparently undervalued financial stocks are actually a value trap for investors looking to take advantage of a bottom.

“Our work seems to suggest that investors have considered only credit conditions and have largely ignored the coming slowdown in global growth,” he wrote in a research note Tuesday. HELOCs “are a bigger issue for small-and mid-cap bank stocks than are mortgages themselves,” he said.

It appears everyone in Washington has a plan to rescue the tens of thousands of “underwater” homeowners in America. What’s unfortunate, as a recent study by The Center for Economic and Policy Research pointed out, is that the proposals currently being circulated are likely to benefit banks more than homeowners.

Dean Baker, co-director of CEPR and author of the study, said that most recent bailout plans, including the one offered by the Office of Thrift Supervision (OTS), will provide little relief for most of the families at risk of losing their homes. Home prices have been falling at a 16% annual rate and will likely continue to fall at least in the near term. This means it’s highly unlikely homeowners will accumulate any equity throughout the duration of the plans.

“Under the OTS plan, falling house prices are particularly problematic, since a homeowner would need to accumulate enough equity to offset the bank’s loss on the initial mortgage before they can claim a dime for themselves,” Baker said. “Since most moderate-income homeowners only stay in their house for relatively short periods of time (the median is four years), most will accumulate no equity at all.”

The study also showed that while these plans may allow some homeowners to stay in their homes, monthly housing payments for those who are helped are likely to be close to 85% higher than if they rent a similar property. Under this logic, Baker argued that if low- and moderate-income homeowners ordinarily spend 30% of their income on shelter costs, the excess costs incurred under a plan like the OTS proposal would be the equivalent of an additional 26 percentage-point income tax.

Furthermore, while the homeowners “helped” will see little benefit, many of the mortgage bailout plans are likely to transfer billions of dollars, and possibly tens of billions of dollars, from taxpayers to mortgageholders, Baker said. Depending on the rate of foreclosure, taxpayers could plausibly end up paying as much as $75,000 for each homeowner who stays in their home — enough to pay for health care for a year for 20 children, the study claimed.

“The current housing crisis was allowed to develop because those in positions of responsibility somehow failed to see an $8 trillion housing bubble,” Baker wrote. “It would be unfortunate if the same people who were responsible for this massive failure were allowed to compound the economy’s problems with ill-conceived bailout plans that are ostensibly designed to help homeowners but really only benefit banks and other mortgage holders.”