Risk-Based Credit Line Management: A Risk-Based Approach Can Reduce a Bank's Exposure to Declining Credit Quality in Consumer Portfolios

By Hulett, Jeffrey P. | The RMA Journal, October 2008 | Go to article overview

Risk-Based Credit Line Management: A Risk-Based Approach Can Reduce a Bank's Exposure to Declining Credit Quality in Consumer Portfolios


Hulett, Jeffrey P., The RMA Journal


Using risk-based credit line management (RBCLM), banks offering consumer lines of credit--secured or unsecured--can protect their interests by proactively reducing or freezing existing limits when credit risk exceeds an acceptable level. This risk level is generally reached when credit quality has deteriorated since the time of origination due to a behavioral change in credit quality (one that is customer controlled) or to a downgrading of collateral value (which is generally market driven).

[FIGURE 1 OMITTED]

The overall decline in home values has focused attention on reducing credit line risk. Figure 1 shows that, in 2008, home values declined up to 14% in some of the nation's largest metropolitan areas and by as much as 26% in markets in California, Arizona, Florida, and Nevada.

In addition, recent home equity line of credit (HELOC) lending standards have tightened. Table 1, which includes the OCC credit survey completed in March of this year, shows that banks are significantly tightening their underwriting standards in home equity. Yet banks are not only trying to reduce risk in new originations; they are also attempting to lower risk in their existing portfolios. While the HELOC product will be the primary focus of this article because home values are of current concern, the RBCLM approach to reducing risk can be applied to other consumer credit products as well.

Several factors can complicate proper execution of an RBCLM program. First, a customer with declining credit quality is likely to use a HELOC as a source of liquidity ("borrowing from Peter to pay Paul"). If the source of liquidity is interrupted, these credits may show higher delinquency rates. Also, reducing or freezing a HELOC will certainly affect the relationship the bank has created with the customer. For these reasons, the bank must take several key steps:

* Use an intensive testing process to identify the customer segments that will respond favorably. (Success of a risk-based credit line management program is measured by an improvement in the net loss rate [losses net of recovery] compared with a control group.)

* Have a disciplined communication program in place to help the customer understand the reason for the action.

* Implement a proactive "cure" program that will reinstate the customer's credit facility once the cause for the remediation action has been addressed.

Before developing an RBCLM program, it is critical to review the primary legal documents to make sure there are no legal stumbling blocks to freezing or reducing lines of credit. Most banks have note language that contains broad provisions allowing reductions in lines due to general reductions in credit or collateral quality. It should be noted that RBCLM programs are generally precollections programs--that is, an RBCLM action could occur when a customer account is current.

Modeling and Targeting

Understanding the risk segments that are driving serious delinquency (60+ days) is a critical, though preliminary, step in the program. Modeling will help the bank understand which credits are likely to default. Unfortunately, there is often a positive relationship between credit risk and HELOC utilization. In other words, as a consumer's credit quality deteriorates, he or she is more likely to use existing credit lines.

The key measure of an RBCLM program's success is to show that reducing or freezing HELOCs reduces the bank's exposure compared with a control group in which no changes are made to HELOC status. If a customer's line is already fully utilized, no savings will be realized by controlling the line. Regardless, freezing the highest risk lines that may not yet be delinquent is a good discipline and has the lowest customer service impact compared with other customers.

Dimensions. There are two primary kinds of dimensions: proprietary and nonproprietary.

* Proprietary dimensions are based on unique or difficult-to-obtain bank customer information, such as detailed bank payment behavior not reported to the credit bureau, combined loan to value (CLTV)/collateral value, income information, and other bank relationships. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Risk-Based Credit Line Management: A Risk-Based Approach Can Reduce a Bank's Exposure to Declining Credit Quality in Consumer Portfolios
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.