THE VALUE OF RECOURSE AND CROSS-DEFAULT CLAUSES IN COMMERCIAL MORTGAGE CONTRACTING

The traditional commercial mortgage contract is written without recour se to any other borrower assets except the subject property. For credi t enhancement purposes, many lenders/investors are today seeking acces s 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 con tingent-claims approach in which borrowers rationally default when the value of the mortgage meets or exceeds the value of the collateral, w here collateral value includes additional assets provided through the mortgage contract. In the case of recourse to an unencumbered asset, d efault risk is reduced in part simply because additional collateral is available. In addition, when the subject property and additional coll ateral are less than perfectly correlated, diversification benefits ar e apparent. In the case of the cross-default clause - which means that default on one loan constitutes default on all loans covered by the c lause - 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.