From Delinquency to Foreclosure a Model of Loan Workout

This paper investigates the impact of recourse on the workout process of portfolio commercial mortgage loans. A generalized model of mortgage workout with stochastic property value appreciation is developed and closed form expressions are derived for the relations between recourse and credit spreads. We find that the recourse provision is effective in offsetting borrower's unwillingness to cooperate by keeping the borrower engaged during the workout process. The prospect of negative equity through a deficiency judgement poses a threat to borrowers thus incentivizing them to resolve distress constructively. As expected, credit spreads exhibit an inverse relationship with respect to recourse with higher recourse loans having lower credit spreads. Somewhat surprising is that we find that this relationship is nonlinear with steep drops in spreads at low levels of recourse. This suggests that relatively low levels of recourse can be used as a substitute to collateral quality