Anna Sarkisyan*Anna Sarkisyan*

under the supervision ofunder the supervision of

Barbara Casu, Andrew Clare, Stephen ThomasBarbara Casu, Andrew Clare, Stephen Thomas

Emerging Scholars in Banking and Finance ConferenceLondon, 9 December 2009

Securitization and Credit Risk Taking:Securitization and Credit Risk Taking: Empirical Evidence from US Bank Holding CompaniesEmpirical Evidence from US Bank Holding Companies

Outline

Introduction Previous Studies Motivation Main Objective and Contributions Securitization and Bank Credit Risk Taking Hypothesis and Empirical Specification Data and Methodology Results Robustness Tests Discussion and Conclusions

Introduction Securitization is a structured process whereby a bank transforms its illiquid assets, traditionally

held until maturity, into marketable securities A typical securitization transaction includes the pooling of endogenous financial assets with fixed

or nearly fixed cash flows and transferring the pool to a special purpose vehicle (SPV), a bankruptcy-remote entity that in turn finances the purchase through the issuance of securities backed by the pool:

The tremendous growth of the securitization market in recent years, and its consequent collapse during the recent financial turmoil, has highlighted the importance of understanding the implications of securitization for the banking sector

Borrower BankSpecial Purpose Vehicle

ABS Investor

CreditEnhancements

Pool of AssetsService

Receivables Cash

Securities

Cash

Rating Agency

TrusteeServicer

Previous Studies Early theoretical studies agree that securitization provides means to reduce bank risk

Greenbaum and Thakor, 1987; Pavel and Phillis, 1987; Hess and Smith, 1988; Zweig, 1989

Further research has investigated the risk effect of securitization from several perspectives:

Quality of assets securitized/retained and the ensuing effect on bank riskCantor and Rouyer, 2000; Dionne and Harchaoui, 2003; Ambrose et al. , 2004; Carey, 1998; Mian and Sufi, 2008; Keys et al., 2008; Dell’Ariccia et al., 2009

Recourse provided by the originating bank and the resulting risk implicationsGorton and Pennacchi,1995; Calomiris and Mason, 2004; Higgins and Mason, 2003; Chen et al., 2008; Vermilyea et al., 2008

Total risk effect for the originating bankKrahnen and Wilde, 2006; Haensel and Krahnen, 2007; Franke and Krahnen, 2005; Cebenoyan and Strahan, 2004; Purnanandam, 2009; Jiangli and Pritsker, 2008

In general the studies suggest a positive link between securitization and bank risk

Motivation By and large, previous empirical studies on how securitization affects the issuing banks suggest

a positive link between securitization and banks’ risk

However, little research has been done to examine the effect of securitization on a particular type of risk, namely credit risk

By allowing banks to convert illiquid assets into liquid funds, securitization may well favor both the expansion of credit supply and the shift towards riskier assets in banks’ portfolios

The existing literature on the former issue shows that securitization reduces the influence of a bank’s financial condition on credit supply (Loutskina and Strahan, 2006)

However, little evidence has been collected on how securitization affects banks’ willingness to extend riskier assets in their portfolios

Main Objective and ContributionsMain Objective:

To focus on a particular type of risk, namely credit risk, and assess the impact of securitization on the credit-risk taking behavior of banks

Contributions: Examines whether securitization has an impact on banks’ credit-risk taking behavior

Tests whether the effect of securitization on the credit-risk taking behavior of banks differs across securitizations of different asset classes

Uses a comprehensive dataset comprising new data on banks’ securitization activities

Securitization and Bank Credit Risk Taking Since securitization provides banks with an additional source of loan financing and

liquidity, it might motivate them to shift their portfolios towards higher risk/return assets (Cebenoyan and Strahan, 2004; Purnanandam, 2009)

However, typically issuing banks retain first-loss contractual interests and/or provide implicit recourse in securitizations. These arrangements mean that the risks inherent in the securitized assets have not been transferred to investors and are, in effect, held by the issuing bank, but off-balance-sheet (Calomiris and Mason, 2004; Chen et al., 2008; Higgins and Mason, 2003; Niu and Richardson, 2006; Vermilyea et al., 2008)

Therefore outstanding securitization exposes the issuing bank to significant credit risk

Assuming that the risk exposure arising from the securitized pool is perceived by the bank, we hypothesize that this should have an impact on the bank’s risk-taking behavior

Hypothesis and Empirical SpecificationHypothesis:

Greater outstanding securitization, and therefore greater credit risk exposure arising from the pool, should make banks more risk-averse and motivate them to shift their portfolios towards assets of lower credit risk

Empirical Specification:

∆CrRi,t – change in the credit risk of bank i's portfolio in period tSeci,t-1 – bank’s outstanding balance of securitized assets scaled by total assets at time t-1Sizei,t-1 – bank size at time t-1Zi,t-1 – vector of bank-specific characteristics at time t-1GDPGi,t - GDP growthQuartert – quarter dummies

' ' ', 1 , 1 2 , 1 , 1 , ,i t i i t i t i t i t t i tCrR Sec Size GDPG Quarter

Data and Methodology US Bank Holding Company (BHC) Data from Y-9CLP forms from 2001:Q2 to 2007:Q4US Bank Holding Company (BHC) Data from Y-9CLP forms from 2001:Q2 to 2007:Q4

42,685 bank-quarters for 2,190 BHCs: 230 securitizers 1,960 non-securitizers

Analysis:Analysis:

i. Univariate analysis of securitizers and non-securitizers

ii. Fixed effects regression analysis using the sample of securitizers: Aggregate outstanding securitization Outstanding securitization by asset type

iii. Robustness Tests

Empirical Results: Univariate Analysis All Banks Securitizers Non-Securitizers Difference in Means Variable

N Mean StD N Mean StD N Mean StD (abs) (%) p-values

Balance Sheet Structure Total Assets ($ billions) 2190 5.254 52.286 230 40.961 156.486 1960 1.064 5.001 39.897 3749.7% 0.000 Liquidity Ratio 2190 0.263 0.123 230 0.247 0.111 1960 0.265 0.124 -0.018 -6.8% 0.029 Loan Ratio 2190 0.664 0.125 230 0.660 0.123 1960 0.665 0.125 -0.005 -0.8% 0.577 Deposits/Assets Ratio 2190 0.681 0.088 230 0.621 0.124 1960 0.688 0.079 -0.067 -9.7% 0.000 Loans/Deposits Ratio 2190 0.999 0.289 230 1.122 0.380 1960 0.984 0.273 0.138 14.0% 0.000 Equity/Assets Ratio 2190 0.091 0.032 230 0.092 0.036 1960 0.091 0.032 0.001 1.1% 0.588 Loan Portfolio Real Estate Loan Ratio 2190 0.708 0.151 230 0.674 0.174 1960 0.712 0.148 -0.038 -5.3% 0.002 C&I Loan Ratio 2190 0.160 0.095 230 0.165 0.086 1960 0.159 0.095 0.006 3.8% 0.373 Consumer Loan Ratio 2190 0.080 0.085 230 0.096 0.115 1960 0.078 0.081 0.018 23.1% 0.018 Other Loan Ratio 2190 0.053 0.081 230 0.065 0.099 1960 0.051 0.079 0.014 27.5% 0.042 Loan HHI 2190 0.585 0.150 230 0.560 0.156 1960 0.588 0.150 -0.028 -4.8% 0.009 Regulatory Capital Tier I Leverage Ratio 2190 9.324 3.822 230 9.274 7.506 1960 9.330 3.120 -0.056 -0.6% 0.910 Tier I Risk-Based Capital Ratio

2190 13.327 6.636 230 12.743 12.168 1960 13.395 5.644 -0.652 -4.9% 0.423 Total Risk-Based Capital Ratio

2190 14.836 6.943 230 14.612 12.742 1960 14.862 5.906 -0.250 -1.7% 0.769 Risk Characteristics Credit Risk 2190 0.712 0.118 230 0.728 0.137 1960 0.710 0.115 0.018 2.5% 0.054 Non-Performing Loan Ratio 2190 0.009 0.008 230 0.010 0.007 1960 0.009 0.008 0.001 11.1% 0.038 Charge-Off Ratio 2190 0.003 0.007 230 0.005 0.012 1960 0.003 0.006 0.002 66.7% 0.017 Loan Loss Provision Ratio 2190 0.004 0.007 230 0.006 0.014 1960 0.004 0.005 0.002 50.0% 0.050 Operating performance Return on Assets 2190 0.011 0.007 230 0.012 0.013 1960 0.011 0.005 0.001 9.1% 0.076 Return on Equity 2190 0.124 0.076 230 0.123 0.126 1960 0.124 0.068 -0.001 -0.8% 0.970 Revenue HHI 2190 0.697 0.094 230 0.644 0.098 1960 0.703 0.092 -0.059 -8.4% 0.000 Interest Income/ Net Operating Revenue 2190 0.7917 0.108 230 0.7126 0.1537 1960 0.801 0.0972 -0.088 -11.0% 0.000 Noninterest Income/ Net Operating Revenue 2190 0.208 0.108 230 0.287 0.154 1960 0.199 0.097 0.088 44.2% 0.000 Securitization Activity Securitized Assets/Loans Ratio

230 0.144 0.515 Securitized Assets/Assets Ratio

230 0.084 0.299

Securitizing banks are significantly larger, hold less liquid assets but more diversified loan portfolios; they are more risky and more profitable institutions earning a higher share of revenue from non-interest income compared to non-securitizers

Empirical Results: Regression Analysis I

Model 1 Model 2 Model 3 Securitization -0.006 -0.006 -0.004 (0.001)*** (0.001)*** (0.001)*** Size 0.005 0.006 -0.004 (0.004)* Loan -0.118 (0.014)*** Capital -0.01 -0.071 ROA -0.027 -0.075 Charge-Off -0.153 (0.092)* GDPG 0.001 0.001 0.000 (0.000)*** (0.000)*** 0.000 Constant -0.001 -0.072 -0.015 -0.002 -0.056 -0.051 Observations 4837 4837 4837 Number of banks 230 230 230 Adjusted R-squared 0.02 0.02 0.06

Empirical Results: Regression Analysis II

(1) (2) (3) (4) (5) (6) (7) (8) Securitization -0.004 (0.001)* Mortgages -0.003 (0.001)* Home Equity Lines -0.426 (0.101)* Credit Cards -0.05 -0.047 Auto Loans 0.045 (0.022)** Other Consumer Loans -0.169 -0.124 C&I loans -0.068 (0.039)*** Other Loans and Leases -0.039 -0.052 Size 0.006 0.006 0.006 0.006 0.006 0.006 0.006 0.006 (0.004)*** (0.004)*** (0.004)*** -0.004 (0.004)*** (0.004)*** (0.004)*** (0.004)*** Loan -0.118 -0.118 -0.12 -0.12 -0.12 -0.119 -0.12 -0.121 (0.014)* (0.014)* (0.013)* (0.013)* (0.013)* (0.014)* (0.013)* (0.014)* Capital -0.01 -0.011 -0.011 -0.017 -0.019 -0.01 -0.014 -0.011 -0.071 -0.071 -0.07 -0.073 -0.071 -0.071 -0.071 -0.072 ROA -0.027 -0.026 -0.042 -0.043 -0.03 -0.034 -0.031 -0.031 -0.075 -0.076 -0.07 -0.07 -0.076 -0.073 -0.074 -0.074 Charge-Off -0.153 -0.158 -0.148 -0.113 -0.163 -0.155 -0.156 -0.154 (0.092)*** (0.092)*** -0.09 -0.095 (0.092)*** (0.092)*** (0.092)*** (0.093)*** GDPG 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 Constant -0.015 -0.014 -0.007 -0.002 -0.008 -0.014 -0.009 -0.008 -0.051 -0.051 -0.05 -0.05 -0.049 -0.05 -0.05 -0.049 Observations 4837 4837 4837 4837 4837 4837 4837 4837 Number of banks 230 230 230 230 230 230 230 230 Adjusted R-squared 0.056 0.056 0.059 0.056 0.056 0.056 0.055 0.056

Robustness Tests

(1) RWATA (2) NPATA All Banks Small Banks Large Banks 2001-2006 All Banks Securitization -0.004 -0.003 -0.015 -0.0036 -0.0002 (0.001)*** (0.0007)* -0.011 (0.0010)* (0.0001)** Size 0.006 0.0041 0.0288 0.0076 0.001 (0.004)* -0.0035 (0.0089)* (0.0043)*** (0.0003)* Loan -0.121 -0.1297 -0.0928 -0.135 0.0019 (0.017)*** (0.0163)* (0.0277)* (0.0171)* -0.0015 Capital -0.012 0.0214 -0.4945 0.0183 -0.005 -0.07 -0.069 (0.1351)* -0.0821 -0.0049 ROA -0.028 -0.0857 0.4177 -0.0122 -0.0443 -0.076 -0.0683 -0.5776 -0.0882 -0.03 Charge-Off -0.152 -0.1032 -0.281 -0.1143 -0.01 -0.092 -0.0892 -0.4573 -0.1032 -0.0164 GDPG 0.0000 0.0000 0.0010 0.0003 -0.0001 0.0000 -0.0004 -0.0011 -0.0004 (0.0000)* Constant -0.009 0.0333 -0.4529 -0.0227 -0.0143 -0.055 -0.0492 (0.1571)* -0.0608 (0.0046)* Observations 4837 3621 486 4271 4837 Number of banks 230 181 25 230 230 Adjusted R-squared 0.06 0.06 0.12 0.064 0.039

Discussion and Conclusions The empirical results indicate a significant negative impact of securitization on bank

credit risk taking, suggesting that banks with a greater amount of securitized assets outstanding choose asset portfolios of lower credit risk

Examining securitization by the type of assets securitized shows that the effect of securitization differs across different asset classes

We explain these findings by the recourse which issuing banks commonly provide, explicitly and/or implicitly, in securitization transactions

The magnitude of recourse required varies across securitizations depending on the nature of the underlying assets; this might explain the found variation in the effect of securitization on bank risk-taking behavior across asset classes

Discussion and Conclusions cont. Taken as a whole, securitization activities are found to have a negative impact on

the credit-risk taking behavior of banks

However, if the proposed recourse hypothesis is correct, the credit risk-reducing effect of securitization might be offset by banks’ greater risk arising from the securitized pool

Therefore, the net impact of securitization on the riskiness of issuing banks is ambiguous and will depend on the structure of transactions, in particular, on the magnitude of credit support provided by banks

This leads us to suggest that banks view securitization as a financing rather than a risk management mechanism

Thank you!

Appendix: Definition of Model Variables

Variable Definition Construction Expected Sign CrR Bank credit risk Risk-Weighted Assets/Total Assets Dependent Variable

Sec Securitization activity of a bank Outstanding Securitized Assets/ Total Assets Negative

Size Size of a bank Ln (Total Assets) Positive

Loan Loan ratio of a bank Loans /Total Assets Negative

Cap Capital ratio of a bank Equity Capital/Total Assets Negative

ROA Return on assets Net Income/Total Assets Negative

ChOff Charge-off ratio of a bank Net Charge-Offs/Loans Negative

GDPG GDP growth GDP real growth rate