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Loan Modifications and the Commercial Real Estate Market

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Abstract
Banks modify more CRE loans than CMBS, contributing to better loan performance when property incomes decline. However, banks have higher delinquency rates for less-stressed loans, consistent with modification policies encouraging strategic default. Motivated by these facts, we develop a tradeoff theory model in which lenders vary in their modification technologies. Modification frictions discourage strategic renegotiation, enabling CMBS to offer higher LTV loans and attract borrowers seeking higher leverage. The model produces cross-lender differences in LTVs and spreads consistent with the data. Reducing modification frictions at CMBS decreases welfare by restricting debt capacity for the borrowers that value it most.

Suggested Citation

  • David P. Glancy & Robert J. Kurtzman & Lara Loewenstein, 2022. "Loan Modifications and the Commercial Real Estate Market," Finance and Economics Discussion Series 2022-050, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2022-50
    DOI: 10.17016/FEDS.2022.050
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    References listed on IDEAS

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    1. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    2. Dirk Hackbarth & Christopher A. Hennessy & Hayne E. Leland, 2007. "Can the Trade-off Theory Explain Debt Structure?," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1389-1428, 2007 04.
    3. Andra Ghent & Rossen Valkanov, 2016. "Comparing Securitized and Balance Sheet Loans: Size Matters," Management Science, INFORMS, vol. 62(10), pages 2784-2803, October.
    4. Lamont Black & John Krainer & Joseph Nichols, 2017. "From Origination to Renegotiation: A Comparison of Portfolio and Securitized Commercial Real Estate Loans," The Journal of Real Estate Finance and Economics, Springer, vol. 55(1), pages 1-31, July.
    5. David Downs & Pisun (Tracy) Xu, 2015. "Commercial Real Estate, Distress and Financial Resolution: Portfolio Lending Versus Securitization," The Journal of Real Estate Finance and Economics, Springer, vol. 51(2), pages 254-287, August.
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    Cited by:

    1. Feng Dong & Yang Jiao & Haoning Sun, 2024. "Bubbly Booms and Welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 53, pages 71-122, July.

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    More about this item

    Keywords

    Commercial real estate; Modifications; LTV;
    All these keywords.

    JEL classification:

    • R33 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Nonagricultural and Nonresidential Real Estate Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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