The Dynamics of Credit Spreads in Hotel Mortgages and Signaling Implications

Abstract

This paper investigates the loan pricing of risk in a market with short term leases (hotels) relative to longer term leases (office properties) with respect to how news on the economy, capital and real estate markets is incorporated in loan pricing using a vector autoregression (VAR) framework. The hotel loan pricing data provides a unique laboratory to study loan pricing adjustments given the short-term nature of the hotel leases. We examine the information content of hotel credit spreads in two stages. After establishing the impact of economic variables on loan pricing and the informational content of the incremental risk spread, we next examine how loan pricing adjusts in response to expected delinquencies. We find that improvement in general economic conditions, an increase in forward looking corporate profitability, an increase in capital availability and/or an increase in the demand for hotel services forecast a decline in the hotel risk premium differential. Thus, the relative loan prices—the spread—reflect systematic risk. We also find that hotel spreads themselves contain important economic information. Unexpected increases in hotel spreads predict hotel delinquencies. In other words, lenders appear to set interest rates on hotel mortgages in anticipation of hotel delinquencies and foreclosures in future periods. Lenders do not appear to consider past delinquencies in their setting their rate.