Implicit Recourse Research Articles

Securitization Under Asymmetric Information Over the Business Cycle

This paper studies the efficiency of financial intermediation through securitization with asymmetric information about the quality of securitized loans. In this theoretical model, I show that, in general, by providing reputation-based implicit recourse, the issuer of a loan can credibly signal its quality. However, in boom stages of the business cycle, information on loan quality remains private, and lower quality loans accumulate on balance sheets. This deepens a subsequent downturn. The longer the duration of a boom, the deeper will be the fall of output in a subsequent recession. In recessions, the model also produces amplification of adverse selection problems on re-sale markets for securitized loans. These are especially severe after a prolonged boom period and when securitized loans of high quality are no longer traded. Finally, the model suggests that excessive regulation that requires higher explicit risk-retention by the originators of loans can adversely affect both quantity and quality of investment in the economy.

Securitization with Implicit Recourse: Some Thoughtson the Economic Rationale

Asset-backed securitization transactions that are structured to achieve a true sale of the underlying assets, i.e., a legal change of ownership, are usually performed “non-recourse.” However, many securitization transactions show signs of implicit recourse, i.e., the granting of non-contractual stipulated support activities of a transaction provided by the originator. The motivation to act as such lies in the originator’s moral hazard to retain his reputation and capital market access. While such measures are officially illegal and regulators stipulate disciplinary consequences, they often tend to ignore such actions. This article analyzes the economic rationale behind the phenomenon of granting implicit recourse in ”non-recourse” securitizations. First, an overview of multiple empirical research shows evidence for the existence of implicit recourse activities in general and even some economic advantages of such measures. Next, a theoretical model based on Benveniste and Berger [1987] shows that recourse can add value to capital market efficiency, because it mitigates the problem of information asymmetry that occurs when financial intermediaries sell their assets. Implicit recourse in securitization transactions might also help to better allocate risk among capital market investors. These theoretical and empirical considerations help us understand the functionality of securitization and of the capital market and its participants. <b>TOPICS:</b>Security analysis and valuation, fixed income and structured finance

Truths, lies and telling silences in Gutiérrez Alea’s The Last Supper and Pontecorvo’s Burn!

Abstract This article explores the special challenges inherent in filmic depictions of New World slavery, and examines how directors Tomás Gutiérrez Alea and Gillo Pontecorvo address these obstacles respectively. Through explicit and implicit recourse to narrative and factual falsehoods, The Last Supper and Burn! both attempt to correct the partial text of history by situating their enslaved characters at the centre of the action and providing them a space in which to express resistance through voice, gesture and determined silence. While each author works from an anti-colonialist, anti-imperialist political stance characteristic of revolutionary film-making in the 1960s and 1970s, significant differences in production environments and directorial decisions regarding the historical record affected each film’s ability to convey the ‘truth’ of Caribbean slavery. Despite the relative successes and failures of each film, I argue that both remain useful tools for fleshing out a textual history in which the enslaved are rarely portrayed as the principal actors of historical events.

Risk taking by US banks led to their failures

This research studies why commercial banks in the USA failed in the recent financial crisis from the aspect of risk taking by the financial institutions. First, lending risks come from the choice of illiquid assets that affect the quality of loans. Second, risk of securitisation is rooted in the implicit recourse, backstop of liquidity, balance sheet overexpansion, and the moral hazard problem. Third, the systemic risk from the overall economic conditions was ubiquitous when market liquidity intertwined with the funding liquidity. Indicators are provided that distinguish surviving banks from their failed peers which serve as the early warning signals that predict banking failures. Given that, this study provides policy options which will contribute to greater stability in the banking sector in a future financial market and economic crisis.

Skin-in-the-Game: Risk Retention Lessons from Credit Card Securitization

The Dodd-Frank Act’s “skin-in-the-game” credit risk retention require- ment is the major reform of the securitization market following the housing bubble. Skin-in-the-game mandates that securitizers retain a 5% interest in their securitizations. The premise behind skin-in-the-game is that it will lessen the moral hazard problem endemic to securitization, in which loan originators and securitizers do not bear the risk on the ultimate performance of the loans. Contractual skin-in-the-game requirements have long existed in credit card securitizations. Their impact, however, has not been previously examined.This Article argues that credit card securitization solves the moral hazard problem not through the limited risk retention of formal skin-in-the-game re- quirements, but through implicit recourse to the issuer’s balance sheet. Absent this implicit recourse, skin-in-the-game actually creates an incentive misalign- ment between card issuers and investors because card issuers have lopsided upside and downside exposure on their securitized card receivables. For- mally, the card issuers bear a small fraction of the downside exposure, but retain 100% of the upside, should the card balance generate more income than is necessary to pay the investors. The risk/reward imbalance should create a distinct problem because the card issuer retains control over the terms of the credit card accounts. Prior to the Credit CARD Act of 2009, the issuer could increase a portfolio’s volatility through rate-jacking: when interest rates and fees are increased, some accounts will pay more and some will default. Per the Black-Scholes option-pricing model, the increased volatility benefits the issuer because of the risk-reward imbalance.Despite the problems posed by the formal risk/reward imbalance, credit card securitization avoided the excesses of mortgage securitization. The ex- planation for this is that credit card securitization features complete implicit recourse. Implicit recourse exists because credit card securitization is not about risk transfer, but instead is about regulatory capital arbitrage and creat- ing a funding and liquidity source for the issuer. The implication is that for- mal skin-in-the-game requirements alone may be insufficient to ensure against moral hazard problems in securitization. Skin-in-the-game’s effectiveness will instead depend on its interaction with other deal features.

Implications Of The Risk-Based Capital Requirements Of Implicit Recourse In Asset Securitizations In The Banking Industry

&lt;p class="MsoBodyText2" style="text-align: justify; line-height: normal; margin: 0in 0.5in 0pt;"&gt;&lt;span style="font-size: 10pt; mso-bidi-font-style: italic; mso-bidi-font-size: 12.0pt;"&gt;&lt;span style="font-family: Times New Roman;"&gt;We consider implications of the risk-based capital requirements of implicit recourse in asset securitizations. These implications include issues in finance such as risk management and contracting between counterparties. The first part of our analysis deals with asset securitizations where originating institutions provide investors with implicit recourse. We show that the risk-based capital requirements associated with the new regulatory definition of implicit recourse may discourage some banks from offering implicit recourse in their asset securitizations. This suggests that the new regulatory definition of implicit recourse may be a workable compromise between supervisory regulators and originating institutions. We then consider a scenario where banks enter into reinsurance contracting with banks in other regions to mitigate some regional economic risks. These reinsurance contracts may enable banks to improve the performance of their balance sheet assets. Although we find weak correlation among equity returns for regional banks, future high correlation among bank portfolios could pose a problem to regulators because when a bank gets into financial distress this may spill over to other network banks. Widening yield spreads in asset securitizations might serve as an early warning signal of financial distress. Thus, regulators might devote more supervisory resources on originating institutions when their asset securitization yield spreads widen.&lt;/span&gt;&lt;/span&gt;&lt;/p&gt;

Implicit recourse and credit card securitizations: What do fraud losses reveal?

In this paper, we develop and test a model of implicit recourse in asset-backed securitizations. Fraud losses on securitized assets are generally incurred by the bank and do not affect the performance of securitization trusts, while credit losses do affect the trust’s performance and are potentially borne by the owner of the securitized assets. Thus, the classification of losses as either fraud or credit losses provides a potential avenue of implicit recourse to manipulate the performance of securitization trusts. Using annual data from 2001 to 2006, we find that the performance of the credit card securitization portfolio is negatively related to fraud losses reported by the bank. We examine these results in light of the proposed Basel II capital rules and argue that a bank’s incentive to provide implicit recourse will increase under the anticipated regime.

Characteristics of Securitizations that Determine Issuers’ Retention of the Risks of the Securitized Assets

ABSTRACT: We hypothesize and provide evidence that characteristics of banks’ loan securitizations accounted for as sales determine the extent to which banks retain the risks of the securitized loans. We show that banks retain more risk when: (1) the types of loans have higher and/or less externally verifiable credit risk, (2) the loans are closed-ended and banks retain larger contractual interests in the loans, and (3) the loans are closed-ended and banks retain types of contractual interests that more strongly concentrate the risk of the securitized loans. We show that the magnitude and type of retained contractual interests are not risk-relevant in revolving loan securitizations, because banks have more incentive and ability to provide implicit recourse, a non-contractual interest.

Characteristics of Securitizations that Determine Issuers' Retention of the Risks of the Securitized Assets

We hypothesize and provide evidence that certain general characteristics of banks' loan securitizations accounted for as sales determine the extent to which banks retain the risks of the securitized loans. We show that banks retain more risk when: (1) the types of loans have higher and/or less externally verifiable credit risk (specifically, commercial loans more than consumer loans more than mortgages), so banks must retain larger contractual or noncontractual first-loss interests in the loans; (2) the loans are closed-ended and banks retain larger contractual interests in the loans; and (3) the loans are closed-ended and banks retain types of contractual interests that more strongly concentrate the risk of the securitized loans (specifically, credit-enhancing interest-only strips more than other subordinated asset-backed securities). We also show that the magnitude and type of retained contractual interests are not risk-relevant in revolving loan securitizations, because banks have more incentive and ability to provide implicit recourse, a noncontractual interest. We infer that banks retain more of the risk of their securitized loans when their total equity risk as measured by future stock return volatility is more positively associated with the off-balance sheet securitized loans and the on-balance sheet contractual retained interests in those loans, all else being equal.

Are Securitizations in Substance Sales or Secured Borrowings? Capital‐Market Evidence*

AbstractTwo standard‐setting approaches have emerged globally to guide the choice of accounting for securitizations: the control and components approach (SFAS No. 125 and SFAS No. 140) and the risks and rewards transfer approach (IAS No. 39). A lack of consensus about derecognition accounting is a major impediment to achieving convergence in global standards that must be resolved. Thus, both SFAS No. 140 and IAS No. 39 will be reexamined, and evidence pertinent to the debate is timely and important. In this study, we present evidence consistent with the view of credit‐rating analysts, who view many securitizations as, in substance, secured borrowings. Specifically, for a sample of originators applying sale accounting guidance in SFAS No. 125 / 140 during the period 1997‐2003, we show that off‐balance‐sheet debt related to securitizations has, on average, the same risk‐relevance for explaining market measures of risk (that is, CAPM beta) as on‐balance‐sheet debt. We also find that, in a returns and earnings association framework, the pricing multiple on securitization gains declines as the amount of off‐balance‐sheet debt increases, implying that investors take off‐balance‐sheet debt into account when assessing the valuation‐relevance of such gains. For those who advocate the control and components approach to securitization accounting, our results suggest that, at least for frequent securitizers, the put option arising from implicit recourse is a “missing piece” that is not currently accounted for when calculating securitization gains. Our results challenge the extant measurement standards in SFAS No. 140.

Credit Card Securitization and Regulatory Arbitrage

This paper explores the motivations and desirability of off-balance-sheet financing of credit card receivables by banks. The authors explore three related issues: the degree to which securitizations result in the transfer of risk out of the originating bank, the extent to which securitization permits banks to economize on capital by avoiding regulatory minimum capital requirements, and whether banks' avoidance of minimum capital regulation through securitization with implicit recourse has been undesirable from a regulatory standpoint. The authors show that this intermediation structure could be motivated either by desirable efficient contracting in the presence of asymmetric information or by undesirable safety net abuse. They find that securitization results in some transfer of risk out of the originating bank but that risk remains in the securitizing bank as a result of implicit recourse. Clearly, then, securitization with implicit recourse provides an important means of avoiding minimum capital requirements. The authors also find, however, that securitizing banks set their capital relative to managed assets according to market perceptions of their risk and seem not to be motivated by maximizing implicit subsidies relating to the government safety net when managing their risk. Thus, the evidence is more consistent with the efficient contracting view of securitization with implicit recourse than with the safety net abuse view. Concerns expressed by policymakers about this form of capital requirement avoidance appear to be overstated.

What is the Value of Recourse to Asset Backed Securities? A Clinical Study of Credit Card Banks

The present paper uses data from revolving credit card securitizations to show that, conditional on being in a position where implicit recourse has become necessary and actually providing that recourse, recourse to securitized debt may benefit short- and long-term stock returns, and long-term operating performance of sponsors. The paper suggests that this result may come about because those sponsors providing the recourse do not seem to be extreme default or insolvency risks. However, sponsors providing recourse do experience an abnormal delay in their normal issuance cycle around the event. Hence, it appears that the asset-backed securities market is like the commercial paper market, where a firm's ability to issue is directly correlated with credit quality. Therefore, although in violation of regulatory guidelines and FASB140, recourse may have beneficial effects for sponsors by revealing that the shocks that made recourse necessary are transitory.

What is the value of recourse to asset-backed securities? A clinical study of credit card banks

The present paper uses data from revolving credit card securitizations to show that, conditional on being in a position where implicit recourse has become necessary and actually providing that recourse, recourse to securitized debt may benefit short- and long-term stock returns, and long-term operating performance of sponsors. The paper suggests that this result may come about because those sponsors providing the recourse do not seem to be extreme default or insolvency risks. However, sponsors providing recourse do experience an abnormal delay in their normal issuance cycle around the event. Hence, it appears that the asset-backed securities market is like the commercial paper market, where a firm's ability to issue is directly correlated with credit quality. Therefore, although in violation of regulatory guidelines and FASB140, recourse may have beneficial effects for sponsors by revealing that the shocks that made recourse necessary are transitory. ; Also issued as Payment Cards Center Discussion Paper No. 03-04

Credit Card Securitization and Regulatory Arbitrage

This paper explores the motivations and desirability of off-balance sheet financing of credit card receivables by banks. We explore three related issues: the degree to which securitizations result in the transfer of risk out of the originating bank, the extent to which securitization permits banks to economize on capital by avoiding regulatory minimum capital requirements, and whether banks' avoidance of minimum capital regulation through securitization with implicit recourse has been undesirable from a regulatory standpoint. We show that regulatory capital arbitrage is an important consequence of securitization. The avoidance of capital requirements could be motivated either by efficient contracting or by safety net abuse. We find that securitizing banks set their capital relative to managed assets according to market perceptions of their risk, and seem not to be motivated by maximizing implicit subsidies relating to the government safety net when managing their risk. This evidence is more consistent with the efficient contracting view of securitization with implicit recourse than with the safety net abuse view.

The delusion of symmetric rights

This article takes a close look at a rhetoric strategy, often used in an attempt to preserve an appearance of neutrality in conflicts over rights. This strategy rests on the concept of symmetry, and in particular concerns symmetry between so-called 'positive rights' (described as the right to obtain or have an object, to engage in an activity, or to enjoy a desired state of affairs) and 'negative rights' (the right not to have this object, not to engage in this activity, or to prevent this state of affairs). When a positive and a negative right protect contradictory options, this strategy conveys that they are of equal standing. The article cautions against the risks entailed by this inference. The deceptive nature of symmetry is first examined in the context of procreation rights and subsequently in other contexts, including conflicts concerning freedom of expression, active euthanasia, and abortion. Our conclusion is that the explicit or implicit recourse to the argument from symmetry is a recurrent feature of rights discourse, deserving attention and cautious handling.