A recent Novantas national survey indicates that roughly one of every five HELOC accounts may be sitting idle. What are the options?
After years of recession-driven contraction, home equity lenders are finally enjoying robust line origination growth. But progress is being compromised by an ongoing accumulation of dormant accounts, with utilization ranging from low to none.
While lender specifics vary, a recent Novantas national survey indicates that roughly one of every five HELOC accounts may be sitting idle, either mothballed for “emergency only” backup or crawling along after former large balances were paid down. It is a nagging problem that has gained fresh urgency as lenders shake off soured recession-era credits and search more earnestly for profitable balance growth.
The larger concern is with emergency only accounts, as illustrated by a behavioral analysis of results from the Novantas 2015 HELOC Consumer Survey. Segmenting customers by reported HELOC usage (both frequency of borrowing and line utilization), 14% of surveyed accountholders were clinging to the sidelines, either never drawing or confining themselves to smaller, infrequent draws, often quickly repaid.
The financial consequences of issuing emergency only lines are quite real, especially considering unfruitful outlays for origination and closing expenses. In a competitive climate that still emphasizes “no fee” origination, lenders are incurring roughly $600 to $1,000 in hard-dollar mortgage closing expenses for each new account — and the all-in cost is easily double that amount, including internal origination expenses and sales incentives.
These large up-front expenses are effectively draining profits from active accounts to subsidize closing costs for dormant ones. Plus there are ongoing capital charges for carrying open lines. Novantas estimates that for HELOC programs at most banks, each percentage point of lost utilization reduces the portfolio return on equity by 10 basis points.
An additional 8% of survey respondents fell into the category of “pay-downs,” or people who have either worked down previous large HELOC balances or have taken only modest draws over the life of the account relationship. These lines represent lost opportunity, especially given the degree to which customers often narrow their HELOC frame of reference to home improvement while overlooking its financing advantages for other needs (appliances, autos, tuition, etc.).
In addressing dormant accounts, the first order of business is to limit and restructure the origination of unused emergency credit. Along with avoidance via improved screening and revised sales incentives, there are opportunities to improve account economics via fee structure revisions. Also there are innovative possibilities with product design, for example, with a prequalified account backed by the promise of expedited processing when customers are really ready to borrow, deferring closing costs until it is clearer that such outlays are warranted.
Another priority is encouraging line utilization. Although established patterns with emergency only and pay-down accountholders may appear unshakeable, our research shows that many people do in fact change their HELOC borrowing patterns over time, reflecting evolving needs — this in spite of the fact that borrower awareness of the full range of HELOC financing possibilities is generally weak. Banks have a lot of work to do in this area, and the good news is that initiatives to boost utilization via improved borrower education and awareness are applicable across the customer base.
Dormant accounts stand in distinct contrast with major, active sectors of the HELOC portfolio. Traditional “periodic borrowers,” for example, make infrequent draws (mostly for home renovation) and carry high balances. This profitable core customer group comprises half of the typical portfolio, based on our behavioral analysis. Another group of “revolvers” encompasses more than a fourth of the portfolio and also carries high balances, but tends to draw more frequently for cash management purposes (Figure 1: HELOC Behavioral Segmentation).
While the origination pipeline is intended to amplify these two groups, it often falls short, either by generating initially profitable accounts that then become wasting assets, or by booking emergency only credit with extremely low draw potential. These drag factors long have gone unaddressed, both in the boom years when the overriding emphasis was on origination volume, and in the protracted post-recession years when credit stabilization had all hands on deck.
While no-fee, high-volume origination practices were the norm during the real estate boom of a decade ago, that is a flawed formula in the post-crisis environment. The pool of eligible borrowers is smaller, for one thing, and overall line utilization is trending down, whether because consumers are more cautious or because HELOCs have been oversold to customers with little more than contingency credit needs (Who would turn down a no-cost line of credit?). Clearly, banks will need to improve the success ratio in generating utilized lines in order to meet their growth targets.
Many factors revolve around the branch, cited as the most-used shopping channel by surveyed accountholders and also the dominant channel for HELOC origination. One issue is customer dialogue and the identification of customer borrowing needs. Among survey respondents who said they had not been considering a HELOC but opened one at the suggestion of the bank, 30% said they never use their lines, raising questions as to whether representatives are doing enough to detect borrower intentions (or merely responding to sales incentives linked to account origination volume, as opposed to HELOC balance formation). Even among people who proactively acquire HELOCs with the intent of contingency usage, the incidence of dormancy is high, raising questions on the adequacy of preparation to profitably engage this customer group.
Once booked, these emergency only accounts run afoul of product design and pricing schemes that suit the core customer base but do not work well beyond it. The assumption behind no-fee origination is that the cost will be more than offset by interest income on substantial carrying balances, often generated at the onset — not true for contingency accountholders. Lengthy draw and repayment periods are typically provided on the assumption that there is high potential for an actively-used long-term borrowing relationship — also not true for contingency borrowers.
Another assumption is that accountholders intuitively grasp HELOC’s advantages over other household financing tools for a variety of borrowing purposes, making it a veritable self-selling product in terms of line utilization — again not true for contingency and pay-down borrowers. The futility is further compounded when the bank resorts to the raw lever of price, for example, offering teaser rates to resuscitate dormant accounts. In fact, our research shows that these customers are the least sensitive to price.
Rethinking Rainy Day Credit
Banks do not want to turn away qualified HELOC applicants but do want to assure that account relationships can be maintained on profitable terms. To strike a better balance with emergency only accountholders going forward, management teams have a number of factors to consider, including sales, product design and pricing.
Sales. Typically the sales process is only loosely set up to detect situations where no-closing-cost origination offers are not warranted. Given the potential that one of every seven approved HELOC applications may wind up shelved for rainy usage only, many management teams will want to review sales incentives, the sales dialogue and performance metrics. Account dormancy should be a formal component of the sales management radar screen.
Product design. With an improved customer dialogue, banks will have more options to present HELOC product variations that will still be helpful to customers but do not over-commit bank resources. With a “prequalified” HELOC, for example, the customer goes through a streamlined application process and, with favorable internal review, then receives a notice of preliminary approval, as with a prequalified first mortgage. With this groundwork in place, the lender can assure applicants of a quick turnaround when they really are ready to borrow, deferring formal line commitments and the incursion of closing costs until better-justified circumstances.
It also may be helpful to selectively introduce shorter or conditional draw periods, both for cost containment and risk management purposes. By halving the typical draw period to five years, for example, the lender still provides an extended borrowing window while limiting the burdens of account maintenance and standby capital. A shorter draw period also helps to limit instances where years have passed since underwriting and approval, the accountholder’s credit profile may have degraded, and suddenly there is an overly large draw relative to the financial carrying capacity of the household.
To go a step further, lenders could even consider an expressly-designed and -packaged “Rainy Day” HELOC product, with flexible characteristics of value to both lender and borrower, backed by a rate and fee structure appropriate for likely usage patterns. Our research shows that most people place their HELOC account with the institution that provides the primary checking account, underscoring the importance of a relationship-friendly context for product innovation.
Finally, product designs should include more lender options to close accounts. Reflecting traditional contractual terms, most of HELOC accounts on the books today cannot be closed for reasons other than delinquency. Left untended, this inflexibility virtually guarantees the ongoing accumulation of dormant accounts.
Fees. Already in the industry, some lenders have introduced annual fees for HELOC accounts, with waivers for a specified balance threshold (Figure 2: Current Fee Structures Among Top HELOC Lenders). A further possibility is to set an origination fee for lines that are booked without an initial draw. Passing along closing costs should not be considered off-limits, especially with rainy-day lines.
As banks revise HELOC product positioning (term structure, fees, differentiated offers for rainy day borrowers), representatives must be prepared for new conversations with customers. Loan officers must be ready to discuss the advantages of waiting to apply or close until the need is more imminent. To align sales and product goals, banks should consider tying at least a portion of sales incentives to line usage, as opposed to a pure focus on new account volume.
Many customers acquire a HELOC with a single borrowing purpose in mind, usually home renovation, and then simply want to retire the debt. Pay-downs represent the tail end of this progression. But the story does not end there.
As part of the HELOC consumer survey, we were able to ask respondents about their original intention for borrowing and actual subsequent usage. Results revealed that HELOC accountholders do a lot of crossing among categories of borrowing purpose, frequently using their lines in ways that differ from their primary stated intention going in. As an example, while 50% of respondents reported line usage for home-related purposes (multiple answers permitted), roughly a third of that usage came from households that acquired a HELOC for a different original purpose. A more dramatic example is big-ticket financing, where more than half of the reported usage came from households that had a different original HELOC borrowing purpose in mind (Figure 3: Borrowing Purposes — Original Intent vs. Actual).
This degree of spontaneous crossover among purpose categories makes a strong case for ongoing product education and promotion within the established customer base. But if feedback from prospective applicants is any indication, a stronger bank effort is needed to educate customers about the full range of HELOC usage possibilities. Among surveyed prospective applicants, 49% said they were unaware that they could use HELOC draws for non-home purposes, and 66% said they were unaware that draws could be used to refinance debt (Figure 4: Awareness of Product Possibilities).
One way to attack the problem is with targeted campaigns to capture “off-us” customer balances held with other lenders. These include revolving and amortized balances parked in alternative vehicles such as student loans, autos and credit cards.
To make clear, such pursuit should not limited to campaigns for dormant accounts only. It has been difficult to focus on marketing during the protracted post-recession years, but the situation is different in the emerging environment of rising home values, rising employment and improving credit quality. As a tax-advantaged household financing tool, HELOC has wide applicability outside of home renovation, with significant untapped potential for off-us balance acquisition and line utilization.
Now several years into the new cycle of line origination growth, banks are hopeful that the stage is being set for sustained balance growth as well. But as underscored by the Novantas 2015 HELOC Consumer Survey, portfolio drag from dormant accounts is an issue to be reckoned with, not only with respect to the current portfolio, but also given the risk of further accumulation under current account design and origination practices.
In diagnosing and addressing this pain point, three major questions come up:
What are the dimensions of the issue? Beyond the fundamentals of account behavior and implications for profitability, it is important to understand the associated customer characteristics. Factors include household demographics, price sensitivity, depth of overall relationship with the bank, estimations of current share of wallet and the potential to capture off-us balances.
What are the options with product design, pricing and fees? For most lenders the immediate priority is to revise the circumstances under which new accounts are being booked, particularly rainy day credit. Current standard offerings are not designed in contemplation of potential widespread dormancy. New alternatives are needed to patch vulnerabilities and promote a heathier origination stream going forward.
What about marketing and sales? Supported by the right analytics — portfolio, customers, and markets — the marketing team can play a lead role in the targeted acquisition and augmentation of HELOC balances, including initiatives to encourage expanded usage for non-home-related purposes. To bring marketing-driven opportunities to full fruition, the sales system needs to be revised so that borrower needs and intentions are proactively detected earlier in the sales dialogue, before application submission.
Of themselves, issues with dormancy-related portfolio drag provide a strong call to action on these three management questions, but most of the trench work is applicable across the customer base and origination stream. As with other retail banking lines of business post-recession, analytically-guided responsiveness will be a requisite to gain profitable HELOC market share in a setting of restrained growth.
Zach Wise is a Principal and Lee Kyriacou is a Managing Director at Novantas Inc., respectively in the Charlotte, N.C. and New York offices. They can be reached at firstname.lastname@example.org and email@example.com. Also contributing was Jenny Cheng, a Senior Associate in the New York office, firstname.lastname@example.org.