Abstract
The study examines risk-specific determinants of credit spreads and underwriting practices for non-recourse commercial real estate loans using property and loan characteristics. We use the case of banks that maintain their loans on balance sheets and concentrate on non-recourse financing of large cash flow-generating properties in Europe and North America. The unique dataset includes the bank’s credit loan ratings, used in a 2-stage least square estimation as an instrument for the LTV ratio to address endogeneity bias. Additionally, we use the debt yield premium as a second instrument to validate our results. Our findings demonstrate that default risk and credit spreads depend on potential changes in cash flow and property value, which may deteriorate future underwriting ratios, as well as on measures taken to mitigate this risk. The results indicate that banks effectively adjust the loan’s minimum debt yield ratio to potential negative changes. • The unique dataset relates data from credit files of non-recourse commercial real estate loans held on banks’ balance sheets. • Credit loan ratings are used as a novel instrument for the LTV ratio in a 2SLS estimation to address endogeneity. • Default risk and credit spreads depend on potential adverse changes in cash flow and property value. • Banks focus on sustainable property income and mitigate risk with long WALTs and amortizing loans.
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