Loss Given Default for Commercial Loans at Failed Banks

Abstract

This paper extends what we know about loss given default (LGD) on commercial loans by studying certain types of these loans that have been excluded from previous research but that may be more representative of loans held by small and mid-sized banks. We use a newly available dataset on commercial loan losses from failed banks that were resolved by the FDIC using loss share agreements. We examine LGD for more than 50,000 distressed loans, broken into three categories: construction and development loans, other commercial real estate loans, and commercial and industrial loans. We compare the characteristics of these loans with those of previous studies and find many similarities as well as significant differences. We explore the relationship between LGD and default date, workout period, loan modification, asset size, bank characteristics, geography, lien status, and other factors that may be related to loss severity. The results inform commercial lenders and regulators about the factors that influence losses on defaulted loans during periods of distress, and provide a useful benchmark for stress testing for smaller banks. To the best of our knowledge, this paper also offers the first published empirical analysis of LGD for construction and development loans.

Keywords: Commercial lending, commercial real estate, CRE, construction and development lending, ADC lending, acquisition/development/construction lending, distressed assets, credit risk, default and loss, loss given default, LGD, recovery rates, liquidation

JEL Classification: G21, G28, G32, G33