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Asset securitization, information asymmetry, and insider trading

Ying ZhouJennifer Wu Tucker

June 2011

Research QuestionDo insiders take advantage of the

information problem related to asset securitizations?

TerminologyAsset securitizationRecourse

◦Explicit recourse (retained interest)◦ Implicit recourse

Risk transferInformation asymmetry

◦Bid-ask spreads◦Analyst disagreement

Insider trading

Asset securitization“Assets”: financial assets of a

company (say, bank), such as mortgage loan receivables, other consumer loan receivables, and commercial loan receivables

Securitization: the company sells a pool of assets to a special purpose entity (SPE), where the SPE raises cash to purchase the assets by selling debt securities to investors

Issuer(bank)

CashLoan receivablesServicing right

SPEcash

ABS(debt

securities)

ABS investors

Bank investors

Asset Securitization

Economic benefits of asset securitization

Better asset portfolio diversification

Higher level of liquidityLower leverage indicated by the

balance sheetLower cost of capital because the

SPE can typically raise funds at a lower rate due to lower expected bankruptcy cost

RecourseABS investors are concerned that the

original loan receivables may go badThe originating bank (issuer) provides

some types of guarantees. Such guarantees are called “recourse.” Also referred to as “credit enhancement tools”◦Explicit recourse: contractual. Retain the

lowest tranch of the asset-backed debt securities

◦Implicit recourse: not obligated but expected

Therefore, securitizationsDelink and repackage the risk and value of

the securitized assets◦securitized assets=transferred interests +

retained interests◦retained interests that concentrate the credit

and other risks of the securitized assets are similar to derivatives

◦A securitization has features of both a sale of the assets and a secured borrowing through the debt securities issued by the SPE

◦The pool of securitized assets varies, the types of debt securities vary, and the recourse terms vary from securitization to securitization – very complex!

Financial reporting and disclosure of asset securitizations

Financial reporting approaches:◦Control and component approach: SFAS 140

and 156◦Risk and reward approach: IAS 39

Companies prefer sale accounting rather than secured-borrowing accounting

Disclosure:◦The concern was “inadequacy”

New reporting and disclosure requirement:◦SFAS 166 and 167 since 2010 Q1

Information uncertainty and information asymmetry

The information uncertainty is regarding the amount and the extent of risk transfers in a securitization

Serious information asymmetry between insiders and outside investors, even if the outside investors are sophisticated institutions

Opportunities for insider tradingCheng et al. (2011 TAR) find that high

information uncertainty at securitizing banks◦Bid-ask spreads◦Analyst disagreement

Insiders are in the best position to understand the implications of the securitizations to the bank

Insiders are top managers, directors, and large investors of ownership of at least 10%

DataU.S. bank holding companies2001Q2 to 2007Q2: 25 quartersAccounting data from the

regulatory Y-9C reports that BHCs file quarterly with the Federal Reserve

Returns data from CRSPInsider trading data from Thomson

Financial

Empirical design Log(ISTRADE) = a0 + a1SECURITIZE + a2SIZE

+ a3TURNOVER + a4|ΔROA| + a5logMB + a6PASTRET + a7FUTURERET + e

Dependent variables also use ISPURCH and ISALLTRADE

Explanatory variables, SECURITIZE, are: (1) SAD (2) SA (3) SMA, SCONA, and SCOMA

Descriptive statistics

N MEAN MEDIAN STDEV Q1 Q3

Insider Trading Variables ISTRADE 6352 0.0231 0.0052 0.0559 0.0011 0.0191 ISPURCH 6352 0.0287 0.0067 0.0692 0.0014 0.0236 ISALLTRADE 6352 0.0113 0.0003 0.0386 0.0000 0.0049

Securitization Variables SAD 6352 0.1606 0.0000 0.3672 0.0000 0.0000 SA 6352 0.0177 0.0000 0.0743 0.0000 0.0000 SMA 6352 0.0113 0.0000 0.0567 0.0000 0.0000 SCONA 6352 0.0021 0.0000 0.0101 0.0000 0.0000 SCOMA 6352 0.0010 0.0000 0.0051 0.0000 0.0000

Control Variables SIZE 6352 5.6379 5.4795 0.7632 5.0846 6.0521

TURNOVER 6352 -1.1974 -1.1819 0.3796 -1.4421 -0.9518 |∆ROA| 6352 0.0006 0.0002 0.0012 0.0001 0.0005 LogMB 6352 0.2849 0.2869 0.1454 0.1926 0.3772 PASTRET 6352 0.0940 0.0703 0.0871 0.0324 0.1277 FUTURERET 6352 0.2008 0.1474 0.1863 0.0683 0.2675

Primary analysis

Estimation 1 Estimation 2 Estimation 3 Estimation 4

Coef. t-statistics Coef. t-statistics Coef. t-statistics Coef. t-statistics

SAD

0.0038 (3.83)*** 0.0037 (3.79)***

SA

0.0181 (3.22)***

SMA

0.0156 (2.11)**^

SCONA

0.0986 (4.37)*** SCOMA

0.0768 (1.91)*^^

SIZE

-0.0078 (-11.97)*** -0.0077 (-11.77)*** -0.0073 (-11.82)*** -0.0078 (-11.96)*** TURNOVER

-0.0076 (-6.26)*** -0.0078 (-6.48)*** -0.0078 (-6.41)*** -0.0076 (-6.30)***

|∆ROA|

0.0525 (0.30)^^^ 0.0234 (0.13)^^^ -0.0081 (-0.04)^^^ -0.0544 (-0.30)^^^ LogMB

0.0027 (0.92)^^^ 0.0033 (1.11)^^^ 0.0032 (1.11)^^^ 0.0041 (1.40)^^^

PASTRET

0.0063 (1.80)*^^ 0.0050 (1.67)*^^ 0.0051 (1.72)*^^ 0.0049 (1.66)*^^ FUTURERET

0.0037 (2.42)**^ 0.0035 (2.29)**^ 0.0036 (2.35)**^

INTERCEPT

0.0423 (10.02)*** 0.0406 (9.44)*** 0.0390 (9.24)*** 0.0416 (9.57)***

Adj-Rsquared

9.74%

9.83%

9.90%

9.94%

N

6,352

6,352

6,352

6,352

ConclusionAlthough financial products facilitate risk transfers

and resource allocations in the capital markets, some are extremely complex and existing financial reporting and disclosure are innately inadequate

The opaqueness provides company insiders opportunities to benefit from their timely private information

We find that insiders are unusually active at banks with active asset securitization activities, suggesting that a consequence of using such a financial engineering vehicle is to open doors for insider trading