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Loss Given Default, Loan Seasoning and Financial Fragility: Evidence from Commercial Real Estate Loans at Failed Banks

Author

Listed:
  • Emily Johnston Ross

    (FDIC)

  • Lynn Shibut

    (FDIC)

Abstract

Commercial real estate (CRE) loan losses are a recurring contributor to bank failures and financial instability, yet they are not well understood. We examine a unique and proprietary data set of CRE loan defaults at banks that failed and were resolved by the FDIC after the 2008 financial crisis. We build upon an existing literature relating stochastic collateral values to loss given default (LGD). Consistent with model predictions, we show that CRE loans defaulting sooner after origination are more sensitive to declining economic conditions and exhibit LGDs that are more severe. These results are robust to a number of factors, including the declining balance of the loan over time. Our findings point to an inherent fragility associated with high CRE loan growth, even without necessarily a deterioration in lending standards, due to the changing composition of CRE loan seasoning in the industry. This reflects an unexplored risk in the literature concerning rapid and cyclical expansions in CRE credit.

Suggested Citation

  • Emily Johnston Ross & Lynn Shibut, 2021. "Loss Given Default, Loan Seasoning and Financial Fragility: Evidence from Commercial Real Estate Loans at Failed Banks," The Journal of Real Estate Finance and Economics, Springer, vol. 63(4), pages 630-661, November.
    • Handle: RePEc:kap:jrefec:v:63:y:2021:i:4:d:10.1007_s11146-020-09783-4
    DOI: 10.1007/s11146-020-09783-4
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    More about this item

    Keywords

    Loss given default; Commercial real estate; Loan seasoning; Collateral; Credit cycles;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • R33 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Nonagricultural and Nonresidential Real Estate Markets

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