Abstract
One of the most important features of securitization is the ability to create securities whose credit risk is based on the quality of a pool of loans rather than the credit risk of the lender who originated the assets. However, the recent failure of many specialized lenders who relied on securitization, and the subsequent extremely poor performance of their securities, raises the question whether the performance of the security can be separated from the financial condition of its sponsor.
Our results suggest a very strong link between the financial condition of the sponsor of an asset-backed security (ABS) and the subsequent performance of the securitization. Securities sponsored by investment-grade financial institutions retain their initial ratings up to 20 percent longer before being downgraded than identically-rated securities that are sponsored by a financial institution with a non-investment grade credit rating. In some specifications, securities sponsored by domestic banks retain their initial rating about 15 percent longer before a downgrade than those sponsored by other types of sponsors. Among domestic firms, securities sponsored by a well-capitalized firm are less likely to be downgraded than those sponsored by a poorly capitalized firm. Diversified lenders — those in more lines of business — also issue better performing securities. Also, securities sponsored by vertically integrated lenders — those who service their own securitizations — retain their initial rating about 9 percent longer than those sponsored by lenders who contract out servicing. In order to control for investor perceptions of risk, we also proxy for yield spread using coupon spread at issuance and find that, while highly statistically significant, the coupon spread does not diminish the estimated effects of the other variables. Finally, we present preliminary evidence that managers may have been aware of some of the risks associated with their troubled securitizations. That is, securitizations whose insiders sold stock in the firm in the three months prior to issuance were downgraded sooner.
These findings suggest that successfully restarting securitization will rely on ensuring that sponsors are well-capitalized and the structure is managed by vertically-integrated institutions that service their own deals. For some lending markets, such as residential and commercial real estate, these conditions would represent an appreciable change from previous practices.