Borrower net equity as a decision variable in industrial mortgage default: The experience of subsidized borrowers in New York State

This study assessed the role of real estate net equity in the industrial borrower's mortgage default decision. Certain public sector lending practices and their relationship to the default outcome were also examined. The theoretical framework combined rational wealth maximizing behavior from microeconomics and option based modeling from finance theory. The mortgage is recognized to contain an implicit put option that allows the borrower to return the property to the lender if net equity becomes negative. A key article from the commercial default literature (Vandell, 1984) was revised and a three step decision process set forth as an alternative framework to default decisionmaking. The model was tested using primary data and a retrospective matched pairs design of 20 defaulted loans paired with 20 non-defaults from the portfolio of the New York State Job Development Authority.Results supported the role of negative net equity in the default decision. The financial costs of default and the three step model were also supported. Lending practices such as original loan guarantees and lending subsidies were not associated with default. The NYJDA may benefit from monitoring negative net equity, liens, and late junior mortgages as advance indicators of default.