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Risk and Delinquency in Mortgages

Paper Session

Sunday, Jan. 5, 2025 8:00 AM - 10:00 AM (PST)

San Francisco Marriott Marquis, Nob Hill B
Hosted By: American Real Estate and Urban Economics Association
  • Chair: Patrick Smith, University of North Carolina-Charlotte

No News is Bad News: Monitoring, Risk, and Stale Financial Performance in Commercial Real Estate

Samuel Hughes
,
U.S. Treasury Department
Joseph Nichols
,
Federal Reserve Board

Abstract

The ability of banks to allocate credit to the economy and manage emerging financial risks depends on their information about those risks and the state of the economy. Banks produce information by monitoring existing loans, which often involves collecting financial performance from borrowers. Using confidential supervisory data on commercial real estate loans (CRE) at large banks, this paper documents the empirical relationship between the content and timeliness of borrower-reported property-level performance, internal bank credit ratings, and subsequent loan performance. Banks heavily rely on borrowers’ performance reporting when setting internal risk ratings. Borrowers with stale or outdated financials are more likely to default, but banks do not promptly revise their internal ratings in response to delayed reporting. Three quasi-experimental empirical exercises provide evidence that banks adjust monitoring in response to loan, location, and portfolio risks. Banks push for more timely financial reporting when they are more exposed to CRE or asset value losses.

Risk Perception and Loan Underwriting in Securitized Commercial Mortgages

Simon Firestone
,
Gro Intelligence
Nathan Godin
,
University of California-Berkeley
Akos Horvath
,
Federal Reserve Board
Jacob Sagi
,
University of North Carolina-Chapel Hill

Abstract

We use model-implied volatility to proxy for property risk perceptions in the commercial real estate lending market. Although~loan-to-value ratios (LTVs) unconditionally decreased following the Global Financial Crisis, LTVs conditioned on implied volatility and other theoretically motivated fundamental determinants of optimal leverage show no conclusive trend before or after the crisis. Taking reported property and loan attributes at face value, we find no clear pattern of unwarranted credit being extended to commercial real estate assets. We conclude that systematically higher LTV decisions pre-crisis would have primarily stemmed from risk misperceptions rather than imprudent practices. Our~findings suggest that the aggregate LTV level should be interpreted as a proxy for lending standards only after controlling for aggregate risk perceptions, among a host of asset and lending market factors. Our~findings also highlight the importance of measuring and tracking aggregate risk perceptions in informing regulators and policymakers.

Exploring Climate Risk, Risk Retention, and CMBS: Understanding their Interplay

Yildiray Yildirim
,
CUNY-Baruch College
Bing Zhu
,
Technical University of Munich

Abstract

In this study, we explore the effects of climate hazards on Commercial Mortgage-Backed Securities (CMBS). While Ouazad and Kahn (2019) discovered a significant increase in mortgage securitizations to agency RMBS following a billion-dollar natural disaster, our results indicate a more cautious approach in response to climate threats, incentivized by the risk retention rule. Following the risk retention rule, CMBS issuers shift their loans away from areas with high climate risks. Meanwhile, loan originators are not able to expedite the sale of loans affected by climate events before they are bundled into securities, and underwriters tend to lower their exposure to climate risks in their loan portfolios. This provides empirical evidence for the “lemon” problem in the securitization model concerning the hidden climate risk in the absence of interest alignment and symmetric information. Consequently, deals under risk retention tend to offer a pricing advantage, with a lower premium for climate hazard exposure. This is linked to a decrease in the default risk associated with climate hazards after the retention rule was put in place.

Evidence on the Determinants and Variation of Idiosyncratic Risk in Housing Markets

Jaqueson Kingeski Galimberti
,
Asian Development Bank
Lydia Cheung
,
Auckland University of Technology
Philip Vermeulen
,
University of Caterbury

Abstract

Using around one million repeat sales, we show that idiosyncratic risk in real house price appreciation varies considerably and systematically across houses. First, we find that idiosyncratic risk is time-varying, depends negatively on the initial house price, varies across locations, and reduces as the holding period of the house increases. Second, these systematic movements in idiosyncratic risk can be explained by time and space variations in market thinness and differences in information quality across markets. We find that borrowing costs and deposit requirements have offsetting effects on risk. Higher interest rates are associated with lower idiosyncratic pricing, while tighter deposit requirements are associated with shorter holding periods, which are subject to a higher risk. Third, we find that the systematic variations in idiosyncratic housing risk are mostly priced in expected returns, except across locations, while the higher risk in shorter holding periods is rewarded with only slightly higher returns. The risk-return relationship across initial house prices depends on the current state of the market. During busts of the housing cycle, the distribution of house prices widens and cheaper houses depreciate faster than more expensive houses, leading to an inverted risk-return relationship.

Discussant(s)
Darren Aiello
,
Brigham Young University
Nancy Wallace
,
University of California-Berkeley
Tingyu Zhou
,
Florida State University
Marco Giacoletti
,
University of Southern California
JEL Classifications
  • R0 - General