USE AT DEFAULT
Used at default is a special behavior case in the use of credit lines. Use at default means using credit facilities to avoid default. This is not a standard term, but it is an important consideration as it is related to credit exposure and usage of liquidity markets.
Naturally, the use of facilities increase implies that there is available liquidity; it also means that credit exposure is increased. In lending liquid markets, borrowers under counterparty stress may use them as a resource of facility provider, for raising additional capital to avoid a default referring to their own existing credit exposure. In marketplace lending this could be the case.It is very difficult to identify and avoid this behavior risk as a liquidity provider, i.e., lender. Liquidity providers may redefine the level of credit lines, but this can send the wrong signal to the markets. As already mentioned, this facility may or may not be used as it really depends on the counterparty's liquidity needs. When such needs are related to financial credit distress of the counterparty it may indicate an increase of default probability and expected credit loss. In the above mentioned case an obligor is using the facility as a last resort to avoid default of another loan. Although the default may not occur, the exposure of the facility is increased together with the overall expected loss of the exposures belonging to this counterparty.
The use of facilities to avoid default is difficult to measure and identify. It could be part of the drawing and potential undrawn exposure of the facility. As shown in Figure 8.4 there are two parts of the facility that are considered: the drawn and undrawn—the former defines the actual and the latter the future potential exposures. Both can be part of the corresponding actual and potential exposures referring to use at default case.
A normal practice to identify such exposures is to have some statistical models of monitoring the use of facilities during the normal financial periods; any changes in the amount and time of exercising the facility option could indicate the use at default behavior risk. Institutions and liquid lending market places are trying to minimize the losses due to such behavior risk by readjusting the lines of the facilities. On the other hand, adjusting the limits of the facilities can increase the distress of the counterparties and default probability.Does use at default matter in marketplace lending? A large share of borrowers use proceeds to refinance loans (58 percent) or consolidate credit card debt (28 percent).9 However, to call this use of funds “use at default” may be a little harsh. Replacing a high-interest loan with a marketplace loan with a fixed lower rate may just be sensible and might have little to do with being at the end of one's rope. Regardless, it is important to know that loans have the potential to serve the purpose of default avoidance. In this case, we need to be aware that their exposure rises rapidly.
8.5
More on the topic USE AT DEFAULT:
- As we mentioned in Chapter 9, the status of a borrower and his contract is either “default” or “non-default.”
- DEFAULT AND DOWNGRADING
- DEFAULT PROBABILITY
- Article 5.6 Europe looks for common default process
- Deliberately opting out of US default rules
- The default posture of human beings is fear.
- As we have seen in Part A, although intestate succession was the default position in Roman law, its rules were such that many Romans were understandably uncomfortable with them.
- If John Darwin is right to claim that empire is the default mode of politics in the history of the world, then the task given to me is well nigh impossible.1
- In classical Roman law, intestacy is the default position: what happens when a sui iuris Roman dies without a will that results in an appointed heir or heirs.
- ADDITIONAL ELEMENTS CONSIDERED IN CREDIT ENHANCEMENTS
- CREDIT RATINGS
- Credit markets, insurance and risk