In the first months of the financial crisis of 200708, a loan servicer is faced with a real estate financing decision. Should you approve a three-year bullet loan to a long-time client, a legendary Texas developer? The real estate developer, who downsized his business shortly before retiring, seeks financing for his only project: residential or commercial development on an attractive lot in a Houston suburb. The loan servicer considers the decision in the context of the turmoil in the mortgage market and considers commercial projects to be safer, but also takes into account that the residential real estate market could generate higher returns if the market stabilizes soon. The manager collects the data and asks an analyst to assess the risks; Ultimately, this requires assessing the profitability of both projects from both the bank and the developer’s point of view. The bank could still change the interest rate on the loan to obtain adequate compensation for the risk it is taking, but the loan officer knows that doing so will change the willingness of its long-term clients to obtain the loan.
Darden School of Business (UV1094-PDF-ENG)
December 31, 2008
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