The value of recourse and cross-default clauses in commercial mortgage contracting

The traditional commercial mortgage contract is written without recourse to any other borrower assets except the subject property. For credit enhancement purposes, many lenders/investors are today seeking access to additional collateral through recourse or cross-default clauses. This paper considers the contracting value of such clauses. To measure these values and assess other related risk statistics, we apply a contingent-claims approach in which borrowers rationally default when the value of the mortgage meets or exceeds the value of the collateral, where collateral value includes additional assets provided through the mortgage contract. In the case of recourse to an unencumbered asset, default risk is reduced in part simply because additional collateral is available. In addition, when the subject property and additional collateral are less than perfectly correlated, diversification benefits are apparent. In the case of the cross-default clause - which means that default on one loan constitutes default on all loans covered by the clause - risk management benefits are also found to be substantial. For example, default risk resulting from a two-asset cross-default clause arrangement can be reduced by over 50 percent of non-recourse default risk when asset values are uncorrelated.