Commercial Mortgage Workout Strategy and Conditional Default Probability: Evidence from Special Serviced CMBS Loans

This study recognizes that commercial mortgage default is not a one-step process and examines a previously unexplored aspect in the whole default process, that is the stage between the initial delinquency and default. We distinguish the servicers' behavior from the borrowers' behavior. A multinomial logit model is applied to analyze the servicers' choice of workout options and a proportional hazard model is applied to analyze the borrower's default decision-making process under time-varying conditions. We find that cash flow condition is the most significant factor in the servicers' decision making process. We also find that borrowers make default decisions based upon both the equity position in the mortgage and the cash flow condition in the space market. Key real estate space market variables, such as market-level vacancy rates, also provide useful information in explaining commercial mortgage defaults. We find that special service seems to be successful in reducing the probability that a troubled loan will default. Finally, sensitivity analysis shows nontrivial economic significance of the impact of explanatory variables, real estate market variables in particular have the most significant impact on the pricing of special-serviced loans.