How do private firms use credit lines?

The authors find that firms that face higher upfront commitment fees, risk premium spreads or usage fees have smaller credit lines, while those with higher overdraft fees have larger ones. Firms with greater profit growth in the past have larger credit lines, while those with more internal funds or higher volatility in profit growth have smaller credit lines. The results for line utilization are quite similar.Corporations - Finance ; Credit ; Loans

Determinants of automobile loan default and prepayment

The authors examine whether a borrower’s choice of automobile reveals information about future loan performance. They find that loans on most luxury automobiles have a higher probability of prepayment, while loans on most economy automobiles have a lower probability of default, even when holding traditional risk factors, such as income and credit score, constant.Automobiles - Prices

Do consumers choose the right credit contracts?

We find that on average consumers chose the contract that ex post minimized their net costs. A substantial fraction of consumers (about 40%) still chose the ex post sub-optimal contract, with some incurring hundreds of dollars of avoidable interest costs. Nonetheless, the probability of choosing the sub-optimal contract declines with the dollar magnitude of the potential error, and consumers with larger errors were more likely to subsequently switch to the optimal contract. Thus most of the errors appear not to have been very costly, with the exception that a small minority of consumers persists in holding substantially sub-optimal contracts without switching. Klassifikation: G11, G21, E21, E5

Do consumers choose the right credit contracts?

A number of studies have pointed to various mistakes that consumers might make in their consumption-saving and financial decisions. We utilize a unique market experiment conducted by a large U.S. bank to assess how systematic and costly such mistakes are in practice. The bank offered consumers a choice between two credit card contracts, one with an annual fee but a lower interest rate and one with no annual fee but a higher interest rate. To minimize their total interest costs net of the fee, consumers expecting to borrow a sufficiently large amount should choose the contract with the fee, and vice-versa. ; We find that on average consumers chose the contract that ex post minimized their net costs. A substantial fraction of consumers (about 40%) still chose the ex post sub-optimal contract, with some incurring hundreds of dollars of avoidable interest costs. Nonetheless, the probability of choosing the sub-optimal contract declines with the dollar magnitude of the potential error, and consumers with larger errors were more likely to subsequently switch to the optimal contract. Thus most of the errors appear not to have been very costly, with the exception that a small minority of consumers persists in holding substantially sub- optimal contracts without switching.Consumer credit ; Contracts

Benefits of relationship banking: evidence from consumer credit markets

This paper empirically examines the benefits of relationship banking to banks, in the context of consumer credit markets. Using a unique panel dataset that contains comprehensive information about the relationships between a large bank and its credit card customers, we estimate the effects of relationship banking on the customers' default, attrition, and utilization behavior. We find that relationship accounts exhibit lower probabilities of default and attrition, and have higher utilization rates, compared to non-relationship accounts, ceteris paribus. Such effects become more pronounced with increases in various measures of the strength of the relationships, such as relationship breadth, depth, length, and proximity. Moreover, dynamic information about changes in the behavior of a customer’s other accounts at the bank, such as changes in checking and savings balances, helps predict and thus monitor the behavior of the credit card account over time. These results imply significant potential benefits of relationship banking to banks in the retail credit market.Consumer credit ; Credit cards

The role of securitization in mortgage renegotiation

We study the effects of securitization on renegotiation of distressed residential mortgages over the current financial crisis. Unlike prior studies, we employ unique data that directly observe lender renegotiation actions and cover more than 60% of the U.S. mortgage market. Exploiting within-servicer variation in these data, we find that bank-held loans are 26% to 36% more likely to be renegotiated than comparable securitized mortgages (4.2 to 5.7% in absolute terms). Also, modifications of bank-held loans are more efficient: conditional on a modification, bank-held loans have lower post-modification default rates by 9% (3.5% in absolute terms). Our findings support the view that frictions introduced by securitization create a significant challenge to effective renegotiation of residential loans.Mortgage loans ; Asset-backed financing ; Securities ; Mortgages

Market-based loss mitigation practices for troubled mortgages following the financial crisis

The meltdown in residential real-estate prices that commenced in 2006 resulted in unprecedented mortgage delinquency rates. Until mid-2009, lenders and servicers pursued their own individual loss mitigation practices without being significantly influenced by government intervention. Using a unique dataset that precisely identifies loss mitigation actions, we study these methods—liquidation, repayment plans, loan modification, and refinancing—and analyze their effectiveness. We show that the majority of delinquent mortgages do not enter any loss mitigation program or become a part of foreclosure proceedings within 6 months of becoming distressed. We also find that it takes longer to complete foreclosures over time, potentially due to congestion. We further document large heterogeneity in practices across servicers, which is not accounted for by differences in borrower population. ; Consistent with the idea that securitization induces agency conflicts, we confirm that the likelihood of modification of securitized loans is up to 70% lower relative to portfolio loans. Finally, we find evidence that affordability (as opposed to strategic default due to negative equity) is the prime reason for redefault following modifications. While modification terms are more favorable for weaker borrowers, greater reductions in mortgage payments and/or interest rates are associated with lower redefault rates. Our regression estimates suggest that a 1 percentage point decline in mortgage interest rate is associated with a nearly 4 percentage point decline in default probability. This finding is consistent with the Home Affordable Modification Program (HAMP) focus on improving mortgage affordability.Asset-backed financing ; Financial crises ; Securities ; Mortgages

Do financial counseling mandates improve mortgage choice and performance? Evidence from a legislative experiment

We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability, and performance of mortgage credit. Our study is based on a legislative experiment in which the State of Illinois required “high-risk” mortgage applicants acquiring or refinancing properties in 10 specific zip codes to submit loan offers from state-licensed lenders to review by HUD-certified financial counselors. We document that the legislation led to declines in both the supply of and demand for credit in the treated areas. Controlling for the salient characteristics of the remaining borrowers and lenders, we find that the ex post default rates among counseled low-FICO-score borrowers were about 4.5 percentage points lower than those among similar borrowers in the control group. We attribute this result to actions of lenders responding to the presence of external review and, to a lesser extent, to counseled borrowers renegotiating their loan terms. We also find that the legislation pushed some borrowers to choose less risky loan products in order to avoid counseling.Financial literacy ; Mortgage loans ; Households - Finance

Do Consumers Choose the Right Credit Contracts?

We analyze an experiment conducted by a large U.S. bank that offered consumers a choice between two credit card contracts, one with an annual fee but a lower interest rate and one with no annual fee but a higher interest rate. We find that on average consumers chose the credit contract that minimized their costs. A substantial fraction of consumers (about 40%) still chose the suboptimal contract. Nonetheless, the probability of choosing the suboptimal contract declines with the dollar magnitude of the potential error, and consumers with larger errors are more likely to subsequently switch to the optimal contract