Positive Payment Shocks, Liquidity and Refinance Constraints and Default Risk Of Home Equity Lines of Credit at End of Draw

54 Pages Posted: 20 May 2016 Last revised: 11 Feb 2020

See all articles by Min Qi

Min Qi

Office of the Comptroller of the Currency - Credit Risk Analysis Division

Harald (Harry) Scheule

University of Technology Sydney (UTS) - School of Finance and Economics; Financial Research Network

Yan Zhang

Government of the United States of America - Office of the Comptroller of the Currency (OCC)

Date Written: February 10, 2020

Abstract

Using a unique and comprehensive dataset of loan-level home equity lines of credit serviced by large US national banks, we confirm that default risk of home equity lines of credit increases at end of draw. More importantly, we quantify the increase in default risk with the size of positive payment shock at end of draw. Furthermore, we find the effects are more pronounced when borrowers are under greater liquidity or refinance constraints and less pronounced if banks manage the credit risk proactively by freezing the credit lines. Our findings are robust across various model specifications and risk segments, payment shock definitions, and after controlling for sample selection bias from HELOC payoffs. These results have important implications for evaluating and managing HELOC credit risk: (i) the need to capture payment shocks, liquidity and refinance constraints in credit risk models, (ii) the benefit of smoothing payment shocks in contract design as well as the workout process, and (iii) the need to consider proper timing for tightening HELOC lending standards.

Keywords: Consumer Liquidity, Constraints, Default, End of Draw, Home Equity Lines of Credit, Lending Standards, Payment Shock, Refinance

JEL Classification: G2, C3

Suggested Citation

Qi, Min and Scheule, Harald and Zhang, Yan, Positive Payment Shocks, Liquidity and Refinance Constraints and Default Risk Of Home Equity Lines of Credit at End of Draw (February 10, 2020). Available at SSRN: https://ssrn.com/abstract=2781359 or http://dx.doi.org/10.2139/ssrn.2781359

Min Qi (Contact Author)

Office of the Comptroller of the Currency - Credit Risk Analysis Division ( email )

250 E Street, SW
Washington, DC 20219
United States

Harald Scheule

University of Technology Sydney (UTS) - School of Finance and Economics ( email )

P.O. Box 123
Broadway, NSW 2007
Australia

HOME PAGE: http://https://www.uts.edu.au/staff/harald.scheule

Financial Research Network ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Yan Zhang

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

400 7th St. SW
Washington, DC 20219
United States
202-6495492 (Phone)

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