Determinants of Credit Spreads in Commercial Mortgages

Abstract

This paper examines the cross-sectional and time-series determinants of commercial mortgage credit spreads as well as the terms of the mortgages. Consistent with theory, our empirical evidence indicates that mortgages on property types that tend to be riskier and have greater investment flexibility exhibit higher spreads. The relationship between the loan to value (LTV) ratio and spreads is relatively weak, which is probably due to the endogeneity of the LTV choice. However, the average LTV ratio per lender has a strong positive relation with credit spreads, which is consistent with the idea that lenders specialize in mortgages with either high or low levels of risk, and that high LTV mortgages require substantially higher spreads. Finally, we observe that spreads widen and mortgage terms become stricter after periods of poor performance of the real estate markets and after periods of greater default rates of outstanding real estate loans.

The Impact of Tenant Diversification on Spreads and Default Rates for Mortgages on Retail Properties

“…Similarly, Nothaft and Freund (2003) estimate a model of credit spreads for multifamily loans with macroeconomic covariates, such as the A-AAA spread and the volatility of the 10-year Treasury bond yield, as well as loan characteristics such as LTV ratios and term to maturity. Titman, Tompaidis and Tsyplakov (2005) estimate a cross-sectional spread model that incorporates a number of loan and property specific characteristics, time dummy variables, and a dummy variable indicating whether or not the originator of the loan is a large investment bank. They find that a number of loan and property characteristics are significantly related to commercial mortgage spreads.…”

The Impact of Tenant Diversification on Spreads and Default Rates for Mortgages on Retail Properties

“…We use this specification because, as is pointed out by Titman et al (2005), LTV is determined endogenously through negotiations between the borrower and the lender. Ceteris paribus, a higher LTV results in a riskier loan and a higher spread.…”

“…We compute the mortgage spread as the difference between the mortgage's interest rate and the interest rate on a maturity matched Treasury security. Following Titman et al (2005), we compute the amortization rate as For each property, we collect data on net operating income (NOI) and the property's appraised value and compute the ratio of NOI to property value. We also collect data on the year the property was built to determine the age of the property at the time of origination.…”

“…Grovenstein et al (2005) point out that lenders consider current tenants and lease structure as part of the risk in commercial mortgage lending. Titman, Tompaidis and Tsyplakov (2005) view property size as a potential proxy for diversification and expect larger properties to have lower spreads at least in part due to this diversification.…”

“…To examine how tenant diversification influences commercial mortgage spreads, we use an empirical model that is similar to the model of Titman, Tompaidis and Tsyplakov (2005). Our model incorporates a number of the same variables to explain commercial mortgage spreads, but we also include measures for tenant diversification and lease rollover risk.…”