Information Asymmetry, Intermediation and Financial Innovation: The Case of Commercial Mortgage Conduit Lending

Abstract

Over the course of recent decades, conduit lending has emerged as an important completing element of the real estate capital markets. Indeed, conduit loans rose to 75% of CMBS issuance in 1998, from less than 5% of CMBS issuance in 1992. However, despite the rapid growth of the conduit market, few papers have sought to model the market completing elements or pricing effects of the conduit sector. In this paper, we present a model which shows how conduits resolve an important information asymmetry problem in the secondary mortgage market. We show that by pooling loans and passing them through to CMBS pools, conduit lenders avoid the lemons problem, so as to largely mitigate under-pricing in the resale of loans into the secondary market. We then conduct empirical analyses to evaluate pricing effects associated with the conduit sector. In so doing, we apply a reduced-form model on about 8,600 conduit and portfolio multifamily mortgage loans sold to private-label CMBS trusts between 1994 and 2000 to assess net coupon paid to investors. After controlling a wide array of loan characteristics, we find that conduit loans enjoy a pricing advantage of 11 bps relative to portfolio loans. Our study provides an information economic model of financial intermediation and explains the increasing prevalence of conduit lending in the commercial mortgage market. We further quantify the pricing effects of conduit lending by estimating the information premium.