ACTITUD HACIA LA INCLUSIÓN

The hypotheses are tested using relative risk ratios in a multinomial logit model. The concept of relative risk refers to the likelihood of early mortgage termination options and partial prepayment behaviour relative to performing mortgages. If the relative risk ratio is greater (smaller) than 1, the probability of early mortgage termination or partial prepayment will be increased (decreased) by the variable

of interest relative to performing loans. Table 5.1 summarizes the hypothesized relative risk ratio of independent variables, whose theoretical support is explained below.

Loan-to-value (LTV) represents the ratio between outstanding loan balance (unpaid mortgage) and the original property value as no update on the initial val- uation is available. Its inverse proxy represents a situation of over-collateralization which can help to reduce mortgage default (Fabozzi 2006[67]). For denying obli- gations, the relative risk ratio is expected to be greater than 1, with an increase in LTV augmenting the likelihood of obligation denial. On the other hand, high debt levels stimulate deleveraging via prepayments. Therefore a positive relationship between the likelihood of prepayment and LTV is expected. Furthermore, incen- tives to deleverage also lead to curtailment and partial defeasance as it makes refinancing with higher loan amounts easier. Thus, the relative risk ratio of LTV is expected to be greater than 1 for partial prepayment too.

Time to maturity: based on credit risk studies such as Fabozzi (2006), credit default is highest at maturity. When the mortgage is far away from the maturity date, a lower default risk is expected, but no clear expectation for prepayment can be formed. Considering the partial prepayment behaviour, future savings in reduced interest payments may offer financial benefits for borrowers with longer terms, so a relative risk ratio greater than 1 is expected for partial prepayment - see McCollum et al. (2015 [125]).

Balloon payment ratios: Goldberg and Capone (2002[91]) explain that a part of principal is required to repay earlier, and thus the risk of denying the obligation should be higher. A positive relationship between the balloon payment and the likelihood of denying obligations is expected, but there is no conclusion on either full or partial prepayment.

Negative amortization rate: negative amortization refers to deferred pay- ment. Brueggeman et al.(2011) point out that higher payments should be made near the maturity of mortgages, but lower payments are made before maturity. Therefore, a lower probability of denying obligations before maturity is expected, but the probability should increase at maturity. Finally, no theoretical support clearly suggest a unique relationship between negative amortization and either full or partial prepayment risk.

Mortgage rate: Ciochetti et al. (2002[44]) and Chen and Deng (2013[37]) conclude that a higher borrowing rate leads to a greater mortgage payment and higher borrowing costs cause higher likelihood of default and prepayment. There- fore, both relative risk ratios are expected to be greater than 1. Similarly, higher borrowing costs stimulate partial prepayment.

Interest only type, i.e. IOM: Corcoran (2000) and Brueggeman et al. (2011) point out that no principal is repaid until maturity for interest-only mortgages and therefore a lower and higher likelihood of denying obligations is expected respectively before and at maturity. The relationships between IOMs and pre- payment risk cannot be inferred a priori.

Cross-collateralization: it represents a type of credit enhancement term to reduce default risk. The mechanism is that all properties serving as collateral for individual loans will serve to collateralize the entire debt as represented by a cross-collateralization agreement. The lender is allowed to call each mortgage within the pool when any one defaults (Fabozzi 2006[67], Brueggeman et al. 2011[33]). Endogeneity in the underwriting process (i.e. a lender assigning cross collateralization in mortgage contracts for less credible borrowers) may make the role of cross-collateralization ambiguous. Therefore, we do not form any expectations about the relationship between cross-collateralization and default and prepayment risks.

Prepayment penalty / yield maintenance: negative relationships are ex- pected between prepayment penalty / yield maintenance and prepayment risk. Elliehausen et al. (2008[62]) show that the default risk premium is inversely related to the presence of a prepayment penalty for fixed-rate and variable-rate mortgages and directly related to prepayment penalty for hybrid mortgages. This shows an unclear relationship between prepayment penalty and denying obliga- tions. As far as the partial prepayment behaviour is concerned, if prepayment penalty / yield maintenance is too high for prepayment in full, borrowers will choose to partially prepay to reduce future interest payments. Thus, the relative risk ratio is expected to be greater than 1 for partial prepayment.

Debt service coverage ratio (DSCR): the ratio between periodical income and mortgage payment represents the borrower’s financial ability to repay period after period. Therefore, the DSCR negatively correlates with the probability of default and the relative risk ratio should be smaller than 1 for denying obligations. This hypothesis is supported by findings in An et al. (2013[16]), Goldberg and Capone (2002[91]) and Seslen and Wheaton (2010[154]). Moreover, higher debts stimulate borrowers to prepay to achieve a reduction in debt level when they are financially capable to do so. Therefore, no unique relationship is expected between DSCR and (full and partial) prepayment risk.

Property age: older properties require more maintenance and hence operat- ing costs may increase. They are also risky as the cost is more uncertain - see Archer et al. (2002 [20]). This reduces the incentive to early terminate mort- gages. On the other hand, mortgages for developments are also risky. As a result,

a non-linear relationship between property age and probability of denying obliga- tions and prepayments are expected. Therefore, we cannot exactly infer unique expectations on relative risk ratios for prepayment.

Occupancy rate: income-producing properties rely on a stable income flow to maintain solvency. The occupancy rate can be used to determine income stability as explained by An et al. (2013 [16]) and Chen and Deng (2013 [37]). A higher occupancy rate is expected to reduce the likelihood of denying obligations. Stable income can provide credits to mortgage borrowers and encourage prepayments. So, the higher the occupancy rate, the greater the prepayment risk. If borrowers earn greater income driven by higher occupancy, they will be more capable of prepaying partially or in full. So relative risk ratios are expected to be greater than 1.

Credit Tenant Lease: Brueggeman et al. (2011) mentions that credit tenant lease reduces the risk of mortgage default as credit tenants are unlikely to default and therefore the relative risk ratio is expected to be smaller than 1. No conclu- sion can be reached for the expected impact of credit tenant lease on prepayment risk instead.

Property supply elasticity: Hilber and Vermeulen (2016[105]) find that prop- erty supply constraints negatively affect fluctuations in property prices, with more inelastic markets showing higher volatility. Hence, mortgage default is more likely to occur in supply inelastic areas. As a result, relative risk ratios should be smaller than 1 for denying obligations. Moreover, as supply inelastic property markets are more volatile, a greater uncertainty of property prices is expected and borrowers cannot easily predict future movements. Therefore, on one hand they may decide to cash in realised gains from capital appreciation by refinanc- ing with higher outstanding loan balance (assuming available LTVs are confirmed as for the previous origination) and distributing the excess value. On the other hand, however, borrowers may prefer to retain the opportunity of further price appreciation by only partially prepaying. In other words, we argue that borrowers strategically prepay a partial amount of the outstanding loan balance to cash in a guaranteed minimum capital gain, but they want to keep the option of further uplift for the remaining part which is not prepaid. As a result, a positive and negative relationship between property supply elasticity and respectively full and partial prepayments is expected.

Property absorption rate: intuitively, less property take-up causes a gloomier outlook on commercial property and a higher mortgage default risk is expected. A negative relationship is expected between office using employment and the probability of denying obligations. This is supported by the findings in An et al.

(2013 [16]). Greater demand may reflect higher income and higher occupancy, thus a greater prepayment risk is expected (i.e. a positive relationship between property absorption rate and prepayment risk). As far as partial prepayment behaviour is concerned, the greater the likelihood of prepayment in full, the less the likelihood of partial prepayment. In other words, a negative relationship between property absorption rate and the likelihood of partial prepayment is expected.

Fixed rate mortgage - FRM - market rate: it demonstrates the market trend of interest rates, which is also discussed in Ambrose and Sanders (2003[15]). In a low interest rate environment, the prepayment risk rises. That leads to the expectation of a negative relationship between market interest rates and prepay- ment risk. However, in general interest rates positively correlate with property prices. If borrowers want to cash in realised profits through property price ap- preciation using prepayment, they will more likely do this in an environment with interest rates increasing. Hence, a negative relationship between market interest rates and prepayment becomes unsure. Furthermore, if market interest rates increase, the default risk may increase for adjustable rate mortgage (ARM) borrowers but less so for FRM borrowers. Therefore, we assume the relationship between the likelihood of denying obligations and market interest rates should be empirically determined.

Inflation indexed Treasury yield: we only examine the impact of Treasury yields on full and partial prepayment bahaviour. Dierker et al. (2005[59]) mention that Treasury yields proxy for the cost of defeasance as it requires the submission of Treasury securities which replicate cash flow patterns of mortgages. If Trea- sury yields are high, a greater defeasance cost is determined and hence a lower likelihood of full or partial defeasance is expected. Odd ratios in the second stage model for full or partial defeasance are expected to be smaller than 1 relative to full prepayment in cash or curtailment.

Table 5.1: Hypothesis Tests

Acronym Variable Relative Risk Ratio

Denying obligations Full Prepayments Partial Prepayments

LT Vm,t LTV ratio (%) >1 >1 >1

T T Mm,t Time to Maturity (month) <1 ? >1

BP Rm,t Balloon Payment Ratio (%) >1 ? ?

N ARm,t Negative Amortization Rate (%) ? ? ?

M Rm,t Mortgage Rate (%) >1 >1 >1

M Tm Mortgage Type (Interest Only) ? ? ?

CCm Cross Collateralization ? ? ?

P P Y Mm,t Prepayment Penalty & Yield Maintenance (%) ? <1 >1

DSCRm,t Debt Service Coverage Ratio (%) <1 ? ?

P Am,t Property Age (Year) ? ? ?

ORm,t Occupancy Rate (%) <1 >1 >1

CT Lm Credit Tenant Lease <1 ? ?

P SEm Property Supply Elasticity <1 >1 <1

P ARm,t Property Absorption Rate in MSA <1 >1 <1

F M Rt Fixed Rate Mortgage Market Rate (%) ? ? ?

IT Yt Inflation Indexed Treasury Yield (%) ? ? ?