Are second liens and home equity loans the new first-lien mortgages? 

While top banks have really struggled to reserve against mortgage (mortgage news) losses and to modify mortgages to prevent losses, we have yet to see equally aggressive action on second liens and home equity loans. But that is starting to change. Wells Fargo has announced it will join the Second-Lien Modification Program offered by the Obama Administration, as will Citigroup, JPMorgan Chase and others. 

The reserving action we've seen so far--mainly with first mortgage in mind--has been impressive, and will likely need to be replicated. CreditSights has estimated potential writeoffs for the top four banks, finding that Wells Fargo is particularly vulnerable. 

The exposure net of estimated reserves: 

• $37.2 billion for Wells Fargo (NYSE: WFC)
• $29.9 billion for JP Morgan (NYSE: JPM)
• $28.6 billion for Bank of America (NYSE: BAC)
• $11.5 billion for Citigroup (NYSE: C)

Of course, the entire exposure will not be written off. But it remains to be seen how many debtors will be able to weather continuing economic storms and how many will qualify for modification. We'll be hearing a lot about this as the top banks report their first quarter results. Bloomberg notes that the issue is "casting a shadow over earnings, as analysts try to determine how much, and how quickly, loan-loss expenses will decline from the industrywide peak reached in June 2009." 

The issue is critical because in many cases the first mortgage modification process is held up by a second mortgage of some sort. Recently, banks may have been reluctant to write-off principal because it implies some second lien or home equity line forgiveness as well, but that may soon change. 

To be sure, large loan loss reserves have been booked already. But surely there is more coming if the industry is serious about modification in general. Jamie Dimon (Jamie Dimon news) told investors in the bank's annual report in February that quarterly writedowns for home-equity loans (not including second liens) "could reach $1.4 billion" in 2010. That would produce record write-offs of $5.6 billion this year, 19 percent more than in 2009 and more than double the amount in 2008, notes Bloomberg. - Jim