Anna Sarkisyan* under the supervision of Barbara Casu, Andrew Clare, Stephen Thomas Emerging Scholars in Banking and Finance Conference London, 9 December 2009 Securitization and Credit Risk Taking: Empirical 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

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 risk Cantor 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 implications Gorton 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 bank Krahnen 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 Contributions Main 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 Specification Hypothesis: 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: ∆CrR i,t – change in the credit risk of bank i's portfolio in period t Sec i,t-1 – bank’s outstanding balance of securitized assets scaled by total assets at time t-1 Size i,t-1 – bank size at time t-1 Z i,t-1 – vector of bank-specific characteristics at time t-1 GDPG i,t - GDP growth Quarter t – quarter dummies

Data and Methodology  US 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: 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 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

Empirical Results: Regression Analysis II

Robustness Tests

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