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The Impact of Positive Payment Shocks on Mortgage Credit Risk – A Natural Experiment from Home Equity Lines of Credit at End of Draw

49 Pages Posted: 20 May 2016  

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; Centre for International Finance and Regulation (CIFR)

Date Written: May 18, 2016

Abstract

Using a unique loan-level residential home equity data from the largest US mortgage servicers that contains a large number of loan attributes and borrower characteristics, we find that default risk of home equity lines of credit (HELOCs) increases with the size of positive payment shocks. Furthermore, default risk increases at end of draw (EOD) when borrowers first experience liquidity constraints and cannot refinance under tightened lending standards. Our findings are robust across different model specifications and risk segments, using clustered standard errors and controlling for the sample selection bias from HELOC payoffs prior to EOD. Since an unprecedented number of HELOCs are expected to reach their EOD period in 2016-2017, we provide several prudential recommendations for lenders and regulators. These include (i) capturing payment shocks and liquidity constraints in credit risk models, (ii) smoothing payment shocks in contract designs as well as work out process, and (iii) coordination in loosening or tightening HELOC lending standards.

Keywords: Default, End of Draw, Home Equity Lines of Credit, Lending Standards, Payment Shock, Payoff, Refinance, Utilization

JEL Classification: G2, C3

Suggested Citation

Qi, Min and Scheule, Harald (Harry), The Impact of Positive Payment Shocks on Mortgage Credit Risk – A Natural Experiment from Home Equity Lines of Credit at End of Draw (May 18, 2016). 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
Sydney
Australia

Financial Research Network ( email )

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

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

Centre for International Finance and Regulation (CIFR) ( email )

Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

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