At the start of this blog series we outlined that millions of home equity lines of credit will be hitting the end of draw (EOD) period over the next few years, which may cause some borrowers to default on their HELOCs due to the payment shock of full amortization (interest plus principal payments). Lenders with and without HELOC portfolios have billions of dollars exposed to borrowers who may be unprepared for this payment shock, thus motivating TU Financial Services analysts to conduct a study to discern actual risk.
To catch up on the first four parts of this series, click on any of the titles below:
- Predicting the Timing of HELOC Payment Shock
- Dimension 1: Credit Risk of the Consumer
- Dimension 2: Consumer Capacity to Absorb Payment Shock
- Dimension 3: Viable Strategy for Exiting the Debt Obligation
Thus far we have demonstrated how three metrics each do an excellent job on their own of identifying which HELOC borrowers may be at elevated risk of default. The next step is to understand what lift we can achieve when these metrics work in concert. To illustrate, consider that we might be less concerned about a consumer with a small AEP if that consumer also has a high credit score: The liquidity risk is offset by a history of sound credit management. Two-dimensional risk matrices help us understand these dynamics. For example, let’s consider the joint distribution of risk between credit score and AEP bands, as shown in Table 4.
Results show us that of the 40% of HELOC borrowers with insufficient AEP, according to our univariate analysis, almost 1/3 have prime risk scores. And of the 24% who have nonprime credit scores, 8% have sufficient AEP. The populations in the lower left corner of the table look particularly grim, with both limited liquidity and poor historical credit performance. These consumers should perhaps be prioritized for treatments to possible payment shock. In the 700-799 credit score tier, those with a positive Capacity to Absorb payment shock (CtA) presented a delinquency rate of only 0.5%, while those with a negative CtA presented a delinquency rate of 2.1%, a factor four times worse. Going further, we see that CLTV also strongly separated risk, with delinquency of 1.7% for those with CLTV less than 90% and 3.4% delinquency for those with CLTV greater than 90%.
These results demonstrate that we have achieved our goal of developing metrics that effectively identify pockets of elevated risk resulting from HELOC EOD payment shock, and that these metrics can be incorporated into risk strategies using traditional analytical methods.
Figure 3 shows similar risk levels among the credit cards held by these HELOC customers as a result of HELOC payment shock. This is further evidence that consumers make choices among products in their wallets in terms of what to pay and what to miss when faced with liquidity constraints. These results are also remarkable given the low levels of card delinquency in our overall data set, indicating that our metrics are powerful indeed at separating risk. Using our metrics, lenders can build these trees across their portfolios using whatever variable cutoffs work best for their individual product and customers mixes, and they can set treatment strategies according to the levels of risk they can tolerate in their portfolios.
This study has yielded a framework for lenders that allows them to understand, anticipate, and measure risk at the individual level. In short, we have empowered lenders to manage the HELOC risk they will face over the next few years and beyond. Our study is only a first step in understanding HELOC risk at the national level. Lenders across product classes should capitalize on the opportunity they have to develop and deploy HELOC risk strategies in the near term – before the wave of HELOC payment shocks hit over the next few years. With appropriate planning, lenders can be well positioned to protect themselves from this risk while maintaining positive, mutually profitable long-term relationships with their customers.
For more on this topic and the study, download the full article Understanding HELOCS: Facts versus Fear, recently featured in the RMA Journal May 2015 edition.
Next steps for mitigating HELOC EOD risk:
- Initiate a portfolio review to understand extent of exposure, how many HELOCS are going to hit end of draw, and individual consumer ability to absorb shock
- Identify and analyze lender risk, pricing, credit limits and metrics around loan to value
- Determine how you move forward with prospective customers
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- For our most recent study on the consumer payment hierarchy, see “Take Heed of Consumers’ Changing Payment Hierarchy” in the December 2013 / January 2014 issue of The RMA Journal.
- For an in-depth discussion of AEP and the related metric, total payment ratio, see “The Almighty Payment: Why It’s Important to Study Debt Service Behaviors” in the March 2014 issue of The RMA Journal.
- Data Source: TransUnion consumer credit database.