Are Commercial Mortgage Defaults Affected by Tax Considerations?

We study whether tax considerations are an important determinant of commercial mortgage default. We also study whether large lenders are better informed, or better at interpreting information for lending purposes, and hence have lower foreclosure rates; whether lenders have more information on larger borrowers than smaller borrowers, and hence have lower foreclosure rates on larger loans; and whether commercial mortgage defaults are related to debt service coverage and loan-to-values, both initial and contemporaneous. The paper’s main findings are fourfold. First, holding all else equal, there is evidence that tax considerations influence investors’ decisions about when to “put” assets to lenders. The results are consistent with the argument of Constantinides (J Financ Econ 13:65–89, 1984). Second, the evidence suggests that large lenders are especially knowledgeable about commercial mortgage borrowers and commercial property markets, in that they have lower foreclosure rates than smaller lenders. Third, on the question of whether lenders have more information on larger borrowers than smaller borrowers, we find that larger loans have, on average, lower default rates than smaller loans. Fourth, the findings suggest that lower default rates are associated with higher debt service coverage ratios, both initial and contemporaneous.     

Legal Restrictions in Personal Loan Markets

This study examines the pricing of personal loans in the form of second mortgages to determine whether state-specific default laws have an effect on the availability and cost of that debt. We examine the pricing of loans to higher risk borrowers and whether borrowers in states that limit lender ability to seek default remedies pay higher credit costs. Our results indicate that, for the most part, lenders rationally price loans to higher risk borrowers. However, when we focus on borrowers with low credit scores, the results indicate that mean actual loan rates are higher than those predicted by our model. The results also indicate that state-specific default laws have an effect on the price of credit. Finally, the results show that there is a greater degree of error in the pricing of second mortgage loans to borrowers with low credit scores than to borrowers with high credit scores.     

Wimp or tough guy: Sequential default risk and signaling with mortgages

When analyzing what to do with a currently defaulted loan, the lender must consider the impact of his foreclosure versus workout decision on the expected payoff of subsequent loans as well as on the payoff of the current loan. This is because borrowers with future loan payoff dates can observe the lender's actions and update prior information regarding the lender's toughness or wimpiness when dealing with defaulted loans. In this paper we consider the strategic interaction between a lender and multiple borrowers, where borrowers have distinct, sequentially maturing mortgage loans and where the lender has private information regarding the magnitude of his foreclosure costs. We find that a variety of strategic outcomes can occur that explain the co-existence of workout and foreclosure in the mortgage marketplace. In general, the lender's workout/foreclosure response depends on the cost of bluffing (e.g., foreclosing when workout is cheaper) versus the value of reducing expected defaults and workout concession losses on future loans (e.g., imperfect foreclosure cost information leads future borrowers to payoff the mortgage when default would have been optimal under perfect information). Given recently revised expectations regarding the depth of the real estate recession, our results may explain the move by many lenders away from granting workout concessions and toward taking a harder line when dealing with defaulting borrowers.     

Cost-benefit analysis of single-family foreclosure alternatives

Over the last ten years, single-family mortgage lenders have become more aware of the financial benefits of finding alternatives to foreclosure for borrowers who default on their mortgage obligations. In this article, expected costs of foreclosure alternatives are parameterized to solve for minimum probabilities of borrower success necessary to make pursuing them profitable for lenders. These break-even probabilities are found to be very insensitive to changes in a variety of factors, including interest-rate environments and time horizons. Simulations are performed across house-price-deflation scenarios, loan-to-value ratios, and post-default cure rates. Stochastic processes are introduced through time distributions for foreclosure processing, property disposition, and house-price appreciation.     

Mortgage Loan Securitization and Relative Loan Performance

We compare the ex ante observable risk characteristics, the default performance, and the pricing of securitized mortgage loans to mortgage loans retained by the original lender. In our sample of loans originated between 2000 and 2007, we find that privately securitized fixed and adjustable-rate mortgages were riskier ex ante than lender-retained loans or loans securitized through the government sponsored agencies. We do not find any evidence of differential loan performance for privately securitized fixed-rate mortgages. We find evidence that privately securitized adjustable-rate mortgages performed worse than retained mortgages, although other observable factors appear to be more economically important determinants of mortgage default. We do not find any evidence of a compensating premium in the loan rates for privately securitized adjustable-rate mortgages.     

Subprime Loan Default Resolutions: Do They Vary Across Mortgage Products and Borrower Demographic Groups?

This paper examines default outcomes for subprime first lien loans during the recent subprime mortgage boom. It conducts this investigation in two phases. The paper first examines factors associated with pre-foreclosure outcomes for subprime mortgages in default. It then examines factors associated with different outcomes for loans that enter foreclosure. These factors include less understood elements such as mortgage product features and borrower demographics. The analysis is based on detailed loan-level data and employs multinomial logit models in a hazard framework. Results show that default resolutions vary with product features and borrower demographics. Adjustable rate and interest-only mortgages, and loans with low- or no-documentation are more likely to enter foreclosure proceedings, and, once in foreclosure, are more likely to become REO. The existence of junior liens increases the probability of the loan remaining in default. Owner-occupancy is associated with lower likelihood of foreclosure initiation and REO, and greater likelihood of curing default. Additionally, default outcomes are impacted by local legal, economic and housing market conditions, and the equity in the home.     

Embedded Options in the Mortgage Contract

Loss mitigation is the process by which lenders attempt to minimize losses associated with foreclosure. As competition increases in the mortgage industry, lenders and servicers are under great pressure to adopt loss mitigation tactics rather than simply use foreclosure as the means of dealing with borrowers in default. This study presents a mortgage-pricing model that fully specifies all borrower options with respect to default, including the ability to reinstate the mortgage out of default. We document the impact of various loss mitigation programs, including forbearance and antideficiency judgments, as well as the value of credit on borrower default behavior.     

Subprime Transitions: Lingering or Malingering in Default?

When a mortgage borrower becomes seriously delinquent (i.e., defaults), the lender initiates a time consuming and complex recovery process that may or may not result in foreclosure and eventual disposition of the real estate collateral (REO). This research studies this transition process for a unique sample of subprime mortgages that were seriously delinquent on September 30, 2001. Eight months later, possible states for the delinquent loans, in order, are 1)to remain delinquent without deteriorating further, 2) foreclosure, 3) worsen, i.e., become more months delinquent, 4) bankruptcy and 5) cure. The data indicate that, relative to prime loans, when subprime loans become seriously delinquent (90 days or longer) they are about twice as likely to become REO but take about four times longer to get there. It is unusual for a subprime default to be cured suggesting considerable forbearance by subprime lenders. We explore determinants of the transition probabilities and find that the most economically important predictors of transition from default to any other state are the number of payments the borrower has made and the loan to value ratio.     

Identifying the Effect of Securitization on Foreclosure and Modification Rates Using Early Payment Defaults

This paper develops and estimates an instrumental variables strategy for identifying the causal effect of securitization on the incidence of mortgage modification and foreclosure based on the early payment default analysis performed by Piskorsi et al. (J Financ Econ 97:360–397, 2010). Estimation results show that securitized mortgages are more likely to be modified and less likely to be foreclosed on by servicers. These results are consistent with the interpretation in Adelino et al. (2009) that low modification rates are not the result of contract frictions inherent in the mortgage securitization process.     

Why don't Lenders renegotiate more home mortgages? Redefaults,self-cures and securitization

A leading explanation for the lack of widespread mortgage renegotiation is the existence of frictions in the mortgage securitization process. This paper finds similarly small renegotiation rates for securitized loans and loans held on banks' balance sheets that become seriously delinquent, in particular during the early part of the financial crisis. We argue that information issues endemic to home mortgages, where lenders negotiate with large numbers of borrowers, lead to barriers in renegotiation. Consistent with the theory, renegotiation rates are strongly negatively correlated with the degree of informational asymmetries between borrowers and lenders over the course of the crisis.     

Does Regulatory Capital Arbitrage, Reputation, or Asymmetric Information Drive Securitization?

Banks can choose to keep loans on balance sheet as private debt or transform them into public debt via asset securitization. Securitization transfers credit and interest rate risk, increases liquidity, augments fee income, and improves capital ratios. Yet many lenders still retain a portion of their loans in portfolio. Do lenders exploit asymmetric information to sell riskier loans into the public markets or retain riskier loans in portfolio? If riskier loans are indeed retained in portfolio, is this motivated by regulatory capital incentives (regulatory capital arbitrage), or a concern for reputation? We examine these questions empirically and find that securitized mortgage loans have experienced lower ex-post defaults than those retained in portfolio, providing evidence consistent with either the capital arbitrage or reputation explanation for securitization.     

Optimal Stopping and Losses on Subprime Mortgages

Lender losses on mortgage loans arise from a two-stage process. In the first stage, the borrower stops making payments if and when default is optimal. The second stage is a lengthy and costly period during which the lender employs legal remedies to obtain possession and execute a sale of the collateral. This research uses data on subprime mortgage losses to explore the role of borrower and collateral characteristics, and local legal requirements, as well as traditional option variables in the decisions of borrowers and lenders. Although subprime borrowers default earlier, which should reduce lender losses, these borrowers, nevertheless, impose greater realized losses on mortgage lenders.     

What Drives Default and Prepayment on Subprime Auto Loans?

This paper uses novel data on the performance of loan pools underlying asset-backed securities to estimate a competing risks model of default and prepayment on subprime automobile loans. We find that prepayment rates increase rapidly with loan age but are not affected by prevailing market interest rates. Default rates are much more sensitive to aggregate shocks than are prepayment rates. Increases in unemployment precede increases in default rates, suggesting that defaults on subprime automobile loans are driven largely by shocks to household liquidity. There are significant differences in the default and prepayment rates faced by different subprime lenders. Those lenders that charge the highest interest rates experience the highest default rates, but also experience somewhat lower prepayment rates. We conjecture that there is substantial heterogeneity among subprime borrowers, and that different lenders target different segments of the subprime market. Because of their higher default rates, loans that carry the highest interest rates do not appear to yield the highest expected returns.     

Effects of Bankruptcy Exemptions and Foreclosure Laws on Mortgage Default and Foreclosure Rates

This study analyzes the effects of state bankruptcy asset exemptions and foreclosure laws on mortgage default and foreclosure rates across different segments of the mortgage market. We found that the effects of these legal provisions are larger for subprime than for prime mortgages and larger for adjustable rate mortgages than for fixed rate mortgages. These results demonstrate that the effect of variation in bankruptcy exemptions and foreclosure laws is most pronounced in the most risky segments of the mortgage market, which are those that have been most affected by the continuing housing slump in the United States.     

Securitization and optimal foreclosure

Does securitization distort the foreclosure decisions of non-performing mortgages? In a model of mortgage-backed securitization with an endogenous foreclosure policy, we find that the securitizing bank adopts a tougher foreclosure policy than the first-best, despite resulting in higher loan losses. This is optimal because foreclosure mitigates the adverse selection problem in securitization by making the optimal security, a risky debt, less information-sensitive. We further show that policies that limit mortgage foreclosure would discourage the bank’s ex ante screening effort, reducing the quality of securitized mortgages. Our model yields novel testable predictions on the effect of mortgage securitization on foreclosure rates, loan performance, and mortgage servicing.     

Predatory lending and the subprime crisis

We measure the effect of a 2006 antipredatory pilot program in Chicago on mortgage default rates to test whether predatory lending was a key element in fueling the subprime crisis. Under the program, risky borrowers or risky mortgage contracts or both triggered review sessions by housing counselors who shared their findings with the state regulator. The pilot program cut market activity in half, largely through the exit of lenders specializing in risky loans and through a decline in the share of subprime borrowers. Our results suggest that predatory lending practices contributed to high mortgage default rates among subprime borrowers, raising them by about a third.     

Securitization and the Declining Impact of Bank Finance on Loan Supply: Evidence from Mortgage Originations

Low-cost deposits and increased balance sheet liquidity raise banks' supply of illiquid loans more than loans easily sold or securitized. We exploit the inability of Fannie Mae and Freddie Mac to purchase jumbo mortgages to identify an exogenous change in liquidity. The volume of jumbo mortgage originations relative to nonjumbo originations increases with bank holdings of liquid assets and decreases with bank deposit costs. This result suggests that the increasing depth of the mortgage secondary market fostered by securitization has reduced the effect of lender's financial condition on credit supply.     

Subprime Mortgage Defaults and Credit Default Swaps

We offer the first empirical evidence on the adverse effect of credit default swap (CDS) coverage on subprime mortgage defaults. Using a large database of privately securitized mortgages, we find that higher defaults concentrate in mortgage pools with concurrent CDS coverage, and within these pools the loans originated after or shortly before the start of CDS coverage have an even higher delinquency rate. The results are robust across zip code and origination quarter cohorts. Overall, we show that CDS coverage helped drive higher mortgage defaults during the financial crisis.     

Foreclosure Delay and Consumer Credit Performance

The deep housing market recession from 2008 through 2010 was characterized by a steep rise in number of foreclosures. The average length of time from onset of delinquency through the end of the foreclosure process also expanded dramatically. Although most individuals undergoing foreclosure were experiencing serious financial stress, the extended foreclosure timelines enabled them to live in their homes without making mortgage payments until the end of the foreclosure process, thus providing temporary income and liquidity benefits from lower housing costs. This paper investigates the impact of extended foreclosure timelines on borrower performance with credit card debt. Our results indicate that a longer period of nonpayment of mortgage expenses results in higher cure rates on delinquent credit cards and reduced credit card balances. Thus, foreclosure process delays may have mitigated the impact of the economic downturn on credit card default—suggesting that improvement in credit card performance during the post-crisis period would likely be slowed by the removal of the temporary liquidity benefits as foreclosures reach completion.     

Beyond the Transaction: Banks and Mortgage Default of Low‐Income Homebuyers

We evaluate the effects of the lending institution and soft information on mortgage loan performance for low‐income homebuyers. We find that even after controlling for the propensity of a borrower to get a loan from a local bank based on observable characteristics, those who receive a loan from a local bank branch are significantly less likely to become delinquent or default than other bank or nonbank borrowers, consistent with an unobserved information effect. These effects are most pronounced for loans originated to borrowers with marginal credit, where soft information may have a stronger effect. These findings support previous research on information‐driven lending, and provide additional explanation for observed differences in mortgage loan performance between bank and nonbank lenders.