Journal of Real Estate Finance and Economics, 17:2, 163±178 (1998)
# 1998 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.
Commercial Mortgage Default: A Comparison of Logit
with Radial Basis Function Networks
National Bank of Greece, Eolou 86, Athens, Greece 102-32
Asset/Liability Management, Federal Home Loan Mortgage Corporation, 8200 Jones Branch Drive,
McLean, VA 22102
Advanta Mortgage Corporation, 850 Ridgeview Dr., Horsham, PA 19044
This article explores the use of arti®cial neural networks in the modeling of foreclosure of commercial mortgages.
The study employs a large set of individual loan histories previously used in the literature of proportional hazard
models on loan default. Radial basis function networks are trained (estimated) using the same input variables as
those used in the logistic. The objective is to demonstrate the use of networks in forecasting mortgage default and
to compare their performance with that of the logistic benchmark in terms of prediction accuracy. Neural
networks are shown to be superior to the logistic in terms of discriminating between ``good'' and ``bad'' loans.
The study performs sensitivity analysis on the average loan and offers suggestions on further improving
prediction of defaulting loans.
Key Words: commercial mortgages, default, prediction, arti®cial neural networks, radial basis functions, logistic
Mortgage default (foreclosure) results when the borrower decides to exercise the default
put option embedded in the mortgage contract (Foster and Van Order, 1984, 1985;
Vandell, 1992; Quigley and Van Order, 1994). In essence, the defaulter exercises the put
option and ``sells'' the property back to the lender in exchange for eliminating the
The American Council of Life Insurance (ACLI) has recently reported that foreclosures
on commercial mortgages in 1994 amounted to $4.4 billion or a proportion of 2.25% of the
commercial mortgage loans. The average loss from foreclosures was 29.04% or $1.28
billion (ACLI, 1995). While foreclosure rates were the lowest since 1990, when they
averaged 1.66% of the mortgage loans, in the middle Atlantic and New England regions
foreclosure rates averaged 5.15 and 4.09%, respectively, in the four quarter of 1994