Loan modifications can ease borrowers’ financial burdens and mitigate loan losses. However, the threat of future strategic renegotiation may cause lenders to tighten ex-ante credit provision. We evaluate this trade-off in a dynamic model of loan underwriting with frictional renegotiation and calibrate it using loan-level CRE data from banks and CMBS. We find that modification frictions can rationalize a number of empirical facts regarding how CRE loan underwriting and performance differ across lenders. Key to this result, high frictions to modifying CMBS loans reduce renegotiation, increase debt capacity, and cause high-leverage-demand borrowers to select into the CMBS market. Consequently, easing CMBS modification frictions reduces welfare by restricting the menu of LTVs available in the market.

Using confidential loan officer survey data on lending standards and internal risk ratings on loans, we document an effect of large-scale asset purchase programs (LSAPs) on lending standards and risk-taking. We exploit cross-sectional variation in banks’ holdings of mortgage-backed securities to show that the first and third round of quantitative easing (QE1 and QE3) significantly lowered lending standards and increased loan risk characteristics. The magnitude of the effects is about the same in QE1 and QE3, and is comparable to the effect of a one percentage point decrease in the Fed funds target rate.