The fear of a bubble, according to TransUnion in a study it released on Thursday basically boils down to fear of the unknown. There may exist a risk that has not even been identified; the potentially affected parties don't understand the ways in which the risk might manifest itself, nor can they determine its timing or who poses the risk because they cannot measure it and so cannot deploy strategies to combat/mitigate/avoid the risk.
In short, there's this big spooky thing that you don't know about and even if you did know about it, you don't understand it, and even if you did understand, you don't know how to use that understanding to protect yourself. Fortunately, Transunion will take care of all that confusing stuff for you.
The less melodramatic thesis is that Transunion sees risks of a second housing bubble arising out of the many Home Equity Lines of Credit or HELOCS that will be nearing the end of their draw period over the next few years. This means that the loans, most of which required only interest payments during the draw period, will begin to amortize, resulting in a larger monthly payment.
TransUnion said its study is intended to measure the extent of the markets exposure to these maturing HELOC loans, to see how consumers who are already in fully amortized repayment are performing, and to provide some effective metrics that lenders can use to manage existing and mitigate future risk.
There are a lot of HELOCS. As of last December there were 15.9 million U.S. consumers with $474 billion in such debt. Still, the HELOC balance is small compared to other loans; over $8 trillion in outstanding home mortgages, $1 trillion in student debt, over $8 billion in auto loans, and $7 billion in credit card balances.
By far the largest volume of HELOCS were originated between 2005 and 2007, some $220 billion. HELOCs are usually structured so that the borrower can draw on the line over a period of 5, 7, or 10 years, making interest payments at a variable rate usually based on the prime lending rate. At the end of the draw (EOD) period the loan is locked and pay down begins over an amortization period of 10 to 15 years.
While some of the loans issued during the boom period should have begun the pay down, by far the largest percentage had draw periods of 5 to 10 years and over 55 percent had draws of 10 years. TransUnion says that as of the end of 2013, 92.4 percent of outstanding loans had not reached EOD, representing outstanding debt of $438 billion, most of which will begin to amortize over the next few years. Further, only 5 percent of these loans have balances under $20,000 while 52 percent have outstanding balances of $100,000 or more.
TransUnion uses as an example of why this is a concern, a HELOC with an $80,000 balance. During the draw period the payment on that loan, with an APR of 7 percent would be $468 and the borrower could, if necessary, borrow from the HELOC line to make that payment. At the end of the draw the loan converts to a 15 year amortizing loan with a payment of $719, a difference of $252 per month, and the draw is no longer available.
Lenders are concerned that this "rate shock" could cause borrowers to default on these loans. There is also a concern that the rate shock could have a domino effect and cause borrowers to default on other loans as well.
TransUnion noted at that certain draw periods were popular during specific time frames and that some lenders tended to favor specific draw periods for loans of certain sizes. This could potentially further concentrate risk.
The company looked at approximately 46,000 HELOCs with an EOD in 2012 and evaluated the default of these borrowers over the following 12 months, not just on the HELOCs but on various other loan products. They looked at the predictive value of credit scores, the ability to absorb payment shock, and cumulative loan to value ratios on consumer performance with the loans and auto loans, credit cards, and mortgages after the EOD.
Looking first at credit scores TransUnion found that 26 percent of the HELOC balances were held by non-prime borrowers - i.e. with TransUnion VantageScores® below 680 - while about 60 percent had scores over 720.
To assess the ability to absorb payment shock TransUnion developed a measure from its credit card histories, determining an AEP or Aggregated Excess Payment metric, defined as the total payments made on cards minus the minimum payment due. This analysis determined that about 40 percent of HELOC balances belong to consumers with less than $500 in AEP, that is little capacity to absorb a payment shock.
Finally TransUnion it looked at the borrowers' ability to exit the loan which it computed by assessing the combined loan to value ratio (CLTV) of the loan to determine the ease of selling or refinancing the house. It found that about 29 percent of balances belonged to consumers with CLTV above 90 percent - that is with an exit value that is limited or non-existent.
All three metrics rank order risk although CLTV does not do so as strongly as the other two. Further TransUnion found interaction effects. Of the 40 percent with an insufficient AEP, 24.1 have prime credit scores and of the 28 percent with non-prime scores, 11 percent appear to have sufficient AEP. Therefore, in TransUnion's words, 18.5 percent of the population looks somewhat grim.
The analysis ultimately determined that between 11 and 19 percent of HELOC balances might be at risk following EOD. This means that about $79 billion of the balances could be at elevated risk of default in the next few years although Steve Chaouki, head of financial services at TransUnion said the study isolated the risk to fewer than 20 percent of balances.
TransUnion said that its study also demonstrated that the elements driving concern over a potential HELOC bubble can be effectively identified, anticipated and measured in order that lenders can manage the risk. Traditional credit risk scores are effective at identifying consumers more likely to default on the HELOCs after EOD and the study also helped to identify several metrics effective at estimating the ability of consumers to absorb payment shock. In addition, the company said, this particular risk will continue to abate as home values increase and unemployment drops.
