Asset Securitization Research Articles

On the China's Local Government Debt Risk

This paper, the formation, scale and constitution of China's local government debt are discussed. The status of various assets available for repayment is thoroughly analysed, including fiscal revenue, government fund revenue, state-owned enterprise profit, state-owned enterprise net assets, state-owned non-operating assets and resource assets. The conclusion is that local governments have a low risk of insolvency; however, due to the mismatching of assets and liabilities, which comes from the low efficiency of investing, there is a certain risk concerning liquidity and payment indeed. The root cause as well as solutions and management of local government debt are also studied, such as, improving the transparency of local debt, implementing of quantitative debt indicators, and establishing the relevant laws to control debt quota. Local government debt risk can be countered by assets securitization, sell and rent, public-private partnerships (PPP), etc.

Securitization and Capital Structure in Nonfinancial Firms: An Empirical Investigation

ABSTRACTContrary to recent accounts of off‐balance‐sheet securitization by financial firms, we show that asset securitization by nonfinancial firms provides a valuable form of financing for shareholders without harming debtholders. Using data from firms’ SEC filings, we find that securitization is attractive to firms in the middle of the credit quality distribution, which are the firms with the most to gain. Upon initiation, firms experience positive abnormal stock returns and zero abnormal bond returns, and largely use the securitization proceeds to repay existing debt. Securitization minimizes financing costs by reducing expected bankruptcy costs and providing access to segmented credit markets.

Securitization under Asymmetric Information and Risk Retention Requirement

We address a three-period model of financial intermediaries that involves securitization of risky loan assets and asymmetric information. We show that the risk retention requirement with a fixed ratio, stipulated by the Dodd-Frank Act, might induce losses of social welfare in the sense that a bank might not utilize profitable investment opportunities due to the regulation, which leads to a downward jump in social welfare. We present various structures of social welfare with respect to the level of ‘skin in the game’, and clarify the necessity of countercyclical regulation by verifying that the social losses caused by current regulation become more severe during a recession. Furthermore, we verify how the financial market becomes volatile through securitization and leverage.

Optimal tranching with diverse beliefs

In this paper, we consider the optimal selling strategy for an asset securitization originator (the issuer) when the potential buyers hold diverse beliefs. We find that the tranching process is beneficial to the issuer because it increases the total sale price. We also consider the optimal tranching strategy that maximizes the revenue of the issuer. This helps explain the widespread use of the tranching technique in the asset securitization practice. Our findings are also enlightening to understand the price bubble problem when the junior tranche is interpreted as a collateral.

Innovation in the Standard of Globalization Sukuk

The purpose of this paper is examination the several of Current Islamic Sukuk models and approaches in Islamic finance. In the aftermath of the financial crisis of 2007–2008, the fundamental stability of the conventional financial system has been seriously questioned. Excessive leveraging, combined with an inherent asset-liability mismatch, exposes institutions to unsupportable risk, and threatens the overall soundness of the financial system. An alternative to the current model is one traditionally advocated by Islam. Islamic finance eliminates debt financing and instead promotes equity or direct asset financing, which allows for risk-sharing instead of risk-shifting. Financial institutions serve their traditional role as intermediaries between savers and investors, but with no debt on their balance sheets, eliminating the potential for excessive risk. The stability of the international financial system would be enhanced if reliance on debt were reduced: the global financial system would rely more heavily on risk-sharing, equity finance, and genuine asset securitization, linking the payoffs of financial securities to the underlying assets that are financed.

The Economics of Securitization: Evidence from the European Markets

Securitization is the process whereby financial assets are pooled together, with their cash flows, and sold to a specially created third party that has borrowed money to finance the purchase. The borrowed funds are raised through the sale of securities, in the form of debt instruments, into the market. Securitization is thus a technique used to transform illiquid assets into securities.Securitization creates value by increasing liquidity and funding, reducing the cost of funding, allowing originators to reach a funding sources diversification, improving originators’ risk management, increasing the segmentation between the origination and investment functions, and allowing originators to benefit from regulatory (and/or tax) arbitrage and to improve key financial ratios.Although the economic advantages, securitization also has problems, especially when used inappropriately. Considering the important role played by securitization in the development and propagation of the 2007/2008 financial crisis, the most commonly referred problems of securitization are complexity, off-balance sheet treatment, asymmetric information problems, agency problems, and higher transaction costs.Besides describing the economic motivations and problems of securitization, this paper provides details on asset securitization characteristics and players, presents the recent trends of securitization markets, describes the role played by securitization in the 2007/2008 financial crisis, and provides some statistics of asset securitization activity in Western Europe between 2000 and 2013.

Risk amplification effect of asset securitization among financial institutions: evidence from CDO products in the USA

This article theoretically and empirically investigates the risk amplification effects of asset securitization among financial institutions in the USA based on a risk model and a single-factor time series model. Results show that systemic risk of financial institutions is enlarged by asset securitization, and the reaction is faster with a larger issuance and holdings of collateralized debt obligation.

Optimal Tranching with Diverse Beliefs

In this paper, we consider the optimal selling strategy for an asset securitization originator (the issuer) when the potential buyers hold diverse beliefs. We find that the tranching process is beneficial to the issuer because it increases the total sale price. We also consider the optimal tranching strategy that maximizes the revenue of the issuer. This helps explain the widespread use of the tranching technique in the asset securitization practice. Our findings are also enlightening to understand the price bubble problem when the junior tranche is interpreted as a collateral.

Corporate Financing Choices after the 2007-2008 Financial Crisis

This paper analyzes the factors that affect the probability of a new borrower choosing between structured debt financing (SF) and straight debt financing (SDF), using a sample of 12,075 Western European loan and bond issues closed during the 2000-2011 period. We find that borrowers choose SF when they seek long-term financing and a reduction in the funding costs. Our results document that floatation costs, information asymmetry, and renegotiation and liquidation risk affect the non-financial firms’ debt financing choice. We also find that financial institutions choose asset securitization when they want to raise relative larger amounts of debt and improve its economic performance. However, our analysis does not provide evidence supporting the hypotheses regarding the transfer of credit risk and regulatory capital arbitrage. In line with mainstream security design literature, our overall results show that SF transactions allow the reduction of the deadweight costs associated with asymmetric information problems, and principal-agent conflicts.

Asset Securitization and Bubbles: An Illustration of Subprime Mortgage Default Crisis

The paper intends to explore the cause and mechanism of subprime mortgage credit crisis occurrence in the United States and thereby the financial crisis resulted. The research indicates that, the outbreak of subprime crisis in the United States in 2007 is the result of multiple factors. Among them, the unreasonable securitization of assets, the excessive creation and over-financing of financial assets and the over-expansion of subprime mortgage credits, and the unceasing inflation and final burst of asset bubbles, are root causes. In addition, the relaxation of government regulation as well as the neglect of efficient guidance and control on real estate markets since 2002 has created a favorable external condition for the sustainable expansion of subprime mortgage credits and the rise of housing prices.

Securitization of residential solar photovoltaic assets: Costs, risks and uncertainty

Limited access to low-cost financing is an impediment to high-velocity technological diffusion and high grid penetration of solar photovoltaic (PV) technology. Securitization of solar assets provides a potential solution to this problem. This paper assesses the viability of solar asset-backed securities (ABS) as a lower cost financing mechanism and identifies policies that could facilitate implementation of securitization. First, traditional solar financing is examined to provide a baseline for cost comparisons. Next, the securitization process is modeled. The model enables identification of several junctures at which risk and uncertainty influence costs. Next, parameter values are assigned and used to generate cost estimates. Results show that, under reasonable assumptions, securitization of solar power purchase agreements (PPA) can significantly reduce project financing costs, suggesting that securitization is a viable mechanism for improving the financing of PV projects. The clear impediment to the successful launch of a solar ABS is measuring and understanding the riskiness of underlying assets. This study identifies three classes of policy intervention that lower the cost of ABS by reducing risk or by improving the measurement of risk: (i) standardization of contracts and the contracting process, (ii) improved access to contract and equipment performance data, and (iii) geographic diversification.

A study on risk retention regulation in asset securitization process

We study the impacts of the recently proposed risk retention regulation for asset securitization, i.e. the issuer has to retain a certain proportion of securitized assets. We also consider the frequently discussed measure to require the issuer disclose certain information of the securitized assets. In a dynamic model with asymmetric information between a risk-averse originating bank and a continuum of risk-averse investors, we find that it is impossible for a flat-rate retention requirement to be optimal for all asset types. Although both risk retention and information disclosure regulations are effective in reducing investors’ informational loss, neither can unconditionally enhance social welfare upon the unregulated case. For both measures, there are associated regulatory cost: risk retention regulation aggravates adverse selection problem because it undermines the channel of informational revelation by the choice of securitization intensity, and information disclosure requirement incurs a signalling cost by distorting banks’ securitization intensity in sending signals. Under an appropriate set of conditions we find that information disclosure requirement complements risk retention regulation when investors are sufficiently risk averse.

Corporate Financing Choices after the 2007-2008 Financial Crisis

We study the factors that, arguably, affect the probability of a new borrower choosing between structured finance (SF), either project finance (PF) loans or asset securitization (AS) bonds, and straight debt finance (SDF) – corporate bonds (CB) – transactions using a large cross section of 24,435 Western European loans and bonds issued between January 1st, 2000 and December 31st, 2011. Borrowers chose an SF transaction when they seek long-term financing and when they operate in a country with lower sovereign rating. Findings suggest that industrials, utilities, transportation, and governmental borrowers exhibit a higher likelihood of an SF transaction, more specifically, a PF transaction. Several macroeconomic factors, like market interest rate levels and volatility, and the slope of the Euro swap curve, positively influence the probability of observing an SF over an SDF transaction. The 2007-2008 financial crisis and the subsequent European sovereign debt crisis have a significant impact on the financing choice, decreasing the probability of observing an AS transaction. During the financial crisis, macroeconomic factors seem to significantly influence the probability of a sponsor to choose SF over SDF. We also find that credit spreads and loan to value ratios have a significant negative relationship for AS bonds. Overall, findings are in line with security design literature. SF transactions or instruments, based on extensively contractual and security design, allow the reduction of the net costs associated with asymmetric information and agency conflicts.

The Changing Landscape of Banking and the Challenges It Poses for Accounting and Financial Reporting

SYNOPSIS This paper summarizes changes that have taken place in banking, the attendant financial innovations, and the challenges these innovations pose for accounting standard setters and regulators. We focus on asset securitizations and the difficulties in accounting for such transactions, in particular their option-like features, and discuss how such option-like features appear in many financial contracts. We discuss ways that such difficulties can be addressed and conclude that a purely recognition-and-measurement approach is likely to be problematic. This suggests that the FASB's approach of requiring an increasing amount of supplementary disclosure relating to the risks faced by banks may be the best solution.

APPLICATION OF ASSET SECURITIZATION IN FINANCING AGRICULTURE IN SERBIA

This paper aims to point out the possibilities of applying asset securitization in financing the Serbian agriculture. Government subsidies and banking loans do not provide sufficient funds so new sources of financing are in need. The process of asset securitization will enable the inflow of funds for agricultural loans approval as well as hedging. Agricultural loans can be used as collateral for issuing securities, although warehouse receipt, repurchase agreement and future income can also serve as collateral. Securitization can enable transfer of risk from insurance companies to financial market through CAT bonds and credit default swaps (CDS). The experience of countries having structured financing in agriculture is valuable for first steps in applying asset securitization in Serbia.

Existence results for fractional differential inclusions arising from real estate asset securitization and HIV models

This paper studies a new class of boundary value problems of nonlinear differential inclusions with Riemann-Liouville integral boundary conditions arising from real estate asset securitization and HIV models. Some new existence results are obtained by using standard fixed point theorems when the right-hand side of the inclusion has convex as well as non-convex values. Some illustrative examples are also discussed. MSC:34A60, 34A08.

The Comparative Analysis of Models for Forestry Asset Securitization

The Comparative Analysis of Models for Forestry Asset Securitization

Insights from the failure of the Countrywide Financial Corporation

Purpose – This paper aims to evaluate the business activities, financial reports, and management compensation practices of Countrywide Financial Corporation (Countrywide) in the period preceding the company's financial distress and leading to its eventual takeover by Bank of America in 2008. This analysis provides a number of insights into the risks that Countrywide was exposed to which may guide future research and financial management. Design/methodology/approach – Case study evaluating the failure of Countrywide Financial Corporation. Findings – First, Countrywide was highly reliant upon the securitization of mortgage loans to finance its activities and this was apparent in the financial reports. Second, these securitization transactions exposed Countrywide to significant financial risks, including the risk inherent in the uncertain values of residual interests and warrantees. Problematically, these risks were not transparently reflected in the financial reports, as confirmed by the lag in the timing of stock price responses. This untimely market response suggests the equity market was not aware of Countrywide's risk exposures until shortly before the company's solvency crisis. Third, the compensation practices of Countrywide encouraged and rewarded management for exposing the firm to significant risks. Practical implications – This paper provides insights into financial management that are relevant for researchers and professionals. Originality/value – This paper provides insights for researchers and practitioners relating to the impact of asset securitization on business risk and how these business activities and risks are disclosed in the financial reports.

Ratings based capital adequacy for securitizations

This paper develops a framework to measure the exposure to systematic risk for pools of asset securitizations and measures empirically whether current ratings-based rules for regulatory capital of securitizations under Basel II and Basel III reflect this exposure. The analysis is based on a comprehensive US dataset on asset securitizations for the time period between 2000 and 2008. We find that the shortfall of regulatory capital during the Global Financial Crisis is strongly related to ratings. In particular, we empirically show that insufficient capital is allocated to tranches with the highest rating. These tranches account for the greatest part of the total issuance volumes. Furthermore, this paper is the first to calibrate risk weights which account for systematic risk and provide sufficient capital buffers to cover the exposure during similar economic downturns. These policy-relevant findings suggest a re-calibration of RBA risk weights and may contribute to the current efforts by the Basel Committee on Banking Supervision and others to re-establish sustainable securitization markets and to improve the stability of the financial system.

What Problem Banks Reveal About Future Financial Distress: Evidence from the Late 2000s Financial Crisis

In this paper, we contribute to a better understanding of the factors related to the operation of the banking system that led to the late 2000s crisis through the development of an early warning model of bank distress. Contrary to all other relevant studies which exclusively focus on bank failures, the current study assumes that bank fragility can result either in a bankruptcy or in a bailout. We employ the dynamic hazard model of Shumway (2001) to develop such an early warning system. Special attention is paid on the relevance of modern financial activities like asset securitisation and derivatives trading in the probability of bank failure and that of bailout. Our empirical findings provide strong evidence that banking firms with illiquid and risky assets, inadequate equity capital, poor management, and low level of earnings have higher probability of failure. However, not all the aforementioned factors are related to the probability of a bank to receive financial assistance in case of a financial debacle. Importantly, we show that banking institutions which rely more on off-balance-sheet activities to finance their operations are more likely to go bankrupt. However, it is easier for these institutions to receive financial aid from authorities. We also provide evidence for the ‘Too-Big-To-Fail’ strategy of banks, as it is found to be less likely for a larger bank to go bankrupt but more likely to obtain financial support from authorities. Overall, our application of the Shumway model is found to be capable of providing bank regulators and supervisors with some of the necessary tools to distinguish healthy from distressed institutions and to work as an effective mechanism for preventing future crises, since its out-of-sample prediction accuracy is found to be very high.