Safe Collateral, Arm's-Length Credit: Evidence from the Commercial Real Estate Mortgage Market *

Abstract When collateral is safe, there are fewer opportunities for lenders to suffer economic losses. We develop a model to show how risky and safe collateral naturally pair with different types of lenders according to how informed the lenders are in states where borrowers are in financial distress. Our application is to the commercial real estate mortgage market where we compare loans funded by commercial mortgage-backed securities (CMBS) to bank loans. We model CMBS investors as lower cost providers of funding, but less informed, and vice-versa for banks. This leads to a separating equilibrium where only safe collateral is funded by CMBS and risky collateral is funded by bank lenders. This prediction is tested using the 2007-2009 shutdown of the CMBS market as a natural experiment, where suddenly collateral usually funded with CMBS were instead financed with bank loans. Our results show that loans with CMBS-like qualities that were "counterfactually" funded by banks were less likely to default or be renegotiated. We conclude that the securitization channel in this market, when available, funds safer collateral