Journal of Credit Risk

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The impact of loan-to-value on the default rate of residential mortgage-backed securities

Luis Otero González, Pablo Durán Santomil, Milagros Vivel Búa and Rubén Lado Sestayo

  • The relation between the probability of default and LTV seems to be nonlinear.
  • A sharp increase is seen for values greater than 80%.
  • The findings confirm the adequacy of the new Basel III proposal.

ABSTRACT

This paper analyzes the validity of using the loan-to-value (LTV) ratio to explain the behavior of mortgage borrowers at an empirical level. To perform this analysis we use data for mortgage loan portfolios securitized in Spain during the period 2005-8. In the regression models developed, we find that higher initial LTV ratios are associated with greater default risk. The relation between the probability of default and LTV seems to be nonlinear, and a sharp increase is seen for values greater than 80%. Our findings confirm the adequacy of the new Basel III proposal that sets nonlinear capital requirement levels for banks holding residential mortgage loans at different LTV ratios. However, the significance shown in the regression models estimated with the "seasoning" variable could be considered in order to improve the models used to measure capital requirements.

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