Loan Origination Research Articles

Capital Requirements, Risk Shifting and the Mortgage Market

We study the effect of changes to bank-specific capital requirements on mortgage loan supply with a new loan-level dataset containing all mortgages issued in the UK between 2005Q2 and 2007Q2. We find that a rise of a 100 basis points in capital requirements leads to a 5.4% decline in individual loan size by bank. Loans issued by competing banks rise by roughly the same amount, which is indicative of credit substitution. Borrowers with an impaired credit history (verified income) are not (most) affected. This is consistent with origination of riskier loans to grow capital by raising retained earnings. No evidence for credit substitution of non-bank finance companies is found.

Marketplace Lending: From the Inside, Looking Out

Over the past decade, we have seen the emergence of a new class of investing known as “marketplace lending,” a growing phenomenon that uses technology to fund billions of dollars in loans across multiple asset classes. At its most basic level, marketplace lending refers to the distributed funding of loans to consumers or businesses, which may or may not take place through a bank intermediary. As an alternative or supplement to balance sheet funding and securitization, loan originators can choose to fund their lending activity through whole-loan sales to diverse groups of investors using an online marketplace. Within a few short years, a multibillion-dollar market with a diverse ecosystem of participants has developed. Although an increasingly large percentage of loans are being gobbled up by asset managers, banks, insurance companies, and hedge funds, institutional capital is finding additional ways to penetrate the market, given the insatiable appetite of yield-hungry investors and a supplyconstrained industry. The overwhelming demand has given rise to a number of marketplace lending securitizations. The U.S. Department of Treasury held its first-ever Marketplace Lending Forum this summer, to discuss 1) the potential for marketplace lending to serve as a new avenue for access to credit by underserved segments of consumers and small businesses and 2) the need to resolve regulatory uncertainty in an efficient and mutually beneficial way. We see all of this activity as a validation of the efforts of so many to develop this industry into a meaningful part of the financial landscape.

Liquidity Provision, Credit Risk and the Bond Spread: New Evidence from the Subprime Mortgage Market

We study the determinants of the subprime mortgage loan spread, with a particular focus on funding liquidity and default-liquidity interaction effects. We find that sector-level as well as macro funding liquidity provision affected subprime loan rates, explaining a significant portion of the variation in spreads. Liquidity conditions just prior to loan default mattered, indicating destabilizing liquidity-driven default effects. A reduction in macro funding liquidity provision at the time of loan origination predicts worsening credit performance, implying a stabilizing default-driven liquidity component in the loan spread. Positive default-liquidity feedback (spiraling) effects are also documented.

Developments in Student Loan Finance

Summer 2015 will mark five years from the end of privatesector origination of student loans under the Federal Family Student Loan Program (FFELP). Since that time, all subsidized and unsubsidized Stafford loans, PLUS loans, and Federal Consolidation loans have been made solely under the Federal Direct Loan Program. This article describes various student loan financing activities prevalent in the financial marketplace, as seen through the eyes of an attorney active in this field, including a lexicon of student loan categories and terms used in the industry, various key criteria that have been developed for student loan securitizations since the financial crisis, currently used student loan asset-backed security (ABS) structures, current regulatory issues, and an outlook for student loan securitization in the future. The student loan ABS asset class has grown since the financial crisis, annualized defaults have declined steadily over the past five years, and the Dodd–Frank burdens are considered onerous but manageable. There is a need for more private-sector student loan ABS origination, but as more student loans are originated by the private sector to creditworthy borrowers, more investors will take notice. Policy changes at the federal level may also present new opportunities for the student loan finance industry. <b>TOPICS:</b>Asset-backed securities (ABS), legal/regulatory/public policy

The Marginal Effect of First-Time Homebuyer Status on Mortgage Default and Prepayment

This paper examines the loan performance of Fannie Mae and Freddie Mac first-time homebuyer mortgages originated from 1996 to 2012. First-time homebuyer mortgages generally perform worse than repeat homebuyer mortgages. But first-time homebuyers are younger and have lower credit scores, home equity, and income than repeat home-buyers, and therefore are comparatively less likely to withstand financial stress or take advantage of financial innovations available in the market. The distributional make-up of first-time homebuyers is different than that of repeat homebuyers in terms of many borrower, loan, and property characteristics that can be determined at the time of loan origination. Once these distributional differences are accounted for in an econometric model, there is virtually no difference between the average first-time and repeat home-buyers in their probabilities of mortgage default. Hence, the difference between the first-time and repeat homebuyer mortgage defaults can be attributed to the difference in the distributional make-up of the two groups and not to the premise that first-time homebuyers are an inherently riskier group. However, there appears to be an inherent difference in the prepayment probabilities of first-time and repeat homebuyers holding borrower, loan, and property characteristics constant. First-time homebuyers are less likely to prepay their mortgages compared to repeat homebuyers even after accounting for the distributional make-up of the two groups using information known at the time of loan origination.

Loan Originations and Defaults in the Mortgage Crisis: Further Evidence

This paper addresses two critiques by Mian and Sufi (2015a, 2015b) that were released in response to the results documented in Adelino, Schoar and Severino (2015). We confirm that none of the results in our previous paper are affected by the issues put forward in these critiques; in particular income overstatement does not drive any of our results. Our analysis shows that the origination of purchase mortgages increased across the whole income distribution during the 2002-2006 housing boom, and did not flow disproportionately to low-income borrowers. In addition, middle- and high-income, as well as middle- and high-credit-score borrowers (not the poor), represent a larger fraction of delinquencies in the crisis relative to earlier periods. The results are inconsistent with the idea that distortions in the origination of credit caused the housing boom and the crisis and are more consistent with an expectations-based view where both home buyers and lenders were buying into increasing housing values and defaulted once prices dropped.

The Monitoring Incentive of Transactional and Relationship Lenders: Evidence from the Syndicated Loan Market

We identify a group of lenders specializing in syndicating tradable loans (referred to as transactional lenders [TLs]). We show that borrowers borrowing from TLs experience worse operating performance and more severe credit quality deterioration after loan origination compared to those borrowing from relationship lenders. This difference in the postloan issue performance remains robust after controlling for the potential self‐selection of the lender type, or using percentage of traded loans out of all syndicated loans to capture lenders’ propensity for syndicating tradable loans. Our results also remains qualitatively the same after we drop various types of risky loans.

The Hidden Peril: The Role of the Condo Loan Market in the Recent Financial Crisis

This article studies the condominium loan market, which experienced a 15-fold increase in origination and constituted 15% of the overall residential loan originations from 2001 to 2007. Condominium loan defaults grow at a faster rate than single-family (including subprime) loan defaults. Further analysis suggests that the greater default level and growth rate in later loan cohorts are consistent with the investor channel explanation: investor borrowers default more, especially when house prices start to decline. We also show that condo defaults have triggered more defaults of the same cohort subprime mortgages at the same location.

Credit Scoring and Loan Default

AbstractA metric of credit score performance is developed to study the usage and performance of credit scoring in the loan origination process. We examine the performance of origination FICO scores as measures of ex ante borrower creditworthiness using loan‐level data on ex post performance of subprime mortgages. Parametric and nonparametric estimates of credit score performance reveal different trends, especially on originations with low credit scores. The data suggest a trend of increased emphasis on higher credit scores accompanying a trend of increased riskiness in other origination attributes. Over time, this increased emphasis on credit scoring coincided with deterioration in FICO performance largely because of the fact that higher credit score originations of later cohorts were more likely to have riskier attributes. However, controlling for other attributes on originations and changes in economic conditions, we find that, as measures of borrower ranking, FICO performance on subprime loans over the years remains fairly stable.

Deregulation, Competition and the Race to the Bottom

We exploit the OCC's preemption of national banks from state laws against preda- tory lending as a quasi-experiment to study the eect of deregulation and its inter- action with competition on the supply of complex mortgages (prepayment penalties, interest-only, and negative amortization). Following the preemption ruling, national banks signi…cantly increased their origination of loans with prepayment penalties and negative amortization features by comparison with lenders not regulated by OCC and lenders in states without predatory lending laws. Further, we highlight a competi- tion channel: in counties where OCC-regulated lenders had larger market shares prior to the preemption, even non-OCC lenders responded by increasing their use of these riskier terms to the extent permitted by the state predatory-lending laws. Overall, our evidence suggests that the deregulation of credit markets triggered a race to the bottomamong distressed …nancial institutions, working through competition between lenders.

What drives the disintegration of the loan origination value chain in the banking business

Purpose– The purpose of this paper is to analyze the vertical disintegration of the bank loan origination value chain. This paper conducts a study on the credit information market from the perspective of the bank’s decision to vertically disintegrate the loan origination value chain. The main aim is to identify the relevant drivers of the decision to vertically disintegrate the credit assessment phase in the lending business.Design/methodology/approach– Transaction cost economics and information asymmetry are the typical perspectives of analysis of the vertical scope of business value chains.Findings– This paper argues that in order to capture the drivers underlying the dynamic evolution of the vertical scope of bank loan origination business models, the above perspectives must be combined and integrated further with a resource-based view and the modularity perspective. Combining managerial and financial perspectives, this paper offers an examination of the drivers of vertical disintegration in the lending value chain and, specifically, in the credit assessment phase.Originality/value– Although the existence of substantial research on value chain vertical integration/disintegration in the literature, none has directly focussed on the credit assessment value chain. It leaves a gap that the paper aims to overcome. The value chain disintegration has deep managerial and financial implications at firm and industry levels, and the comprehension of the rational underlying it is critical to maintaining competitive business model configurations in the bank lending industry.

Interconnectedness, systemic crises, and recessions

In this paper, we construct a simple model designed to capture four widely held views about financial crises: [1] Interconnectedness among financial institutions (banks) can play a major role in precipitating systemic financial crises. [2] It does so by introducing loan-portfolio opacity, reducing the quality of information about portfolio risk. [3] Financial crises, particularly systemic ones, often are followed by serious recessions. [4] A loss of confidence in the financial system is partly responsible for the length and severity of these recessions. In the model, banks assess loan risk, originate and liquidate loans, and acquire loans originated by other banks. Interconnectedness of this sort can obscure information, resulting in banks making inefficient decisions about liquidating loans and choosing loan originators (who assess risk). Inefficient liquidation can deepen recessions and lead to systemic financial crises; less effective risk assessment can increase the probability of lengthy, severe recessions. The government may wish to increase the transparency of bank portfolios by limiting interconnectedness. The optimal degree of regulation may depend on depositors’ degree of risk aversion and may not eliminate financial crises.

Earnings Announcements, Information Asymmetry and Timing of Debt Offerings

We empirically examine the joint predictions of the pecking order theory and the theory of time-varying asymmetric information regarding the timing of security offerings around information disclosures. We analyze loan originations and bond offerings around earnings announcements and compare them against equity offerings. In support of the theories’ predictions, we find a positive association between the information sensitivity of securities and the likelihood of their issuance after earnings announcements. In particular, we find that clustering after earnings announcements is weakest in loan originations, stronger in bond offerings, and strongest in equity offerings. Also consistent with the theories, we find that the size of news in earnings announcements matters in the timing decision. We find weak evidence regarding the theories’ implication that the direction of news in the announcement plays a role in the timing decision. We test and find that this latter result is attributable partly to potential costs associated with the omission of material negative information, such as litigation risk.

Earnings Announcements, Information Asymmetry, and Timing of Debt Offerings

ABSTRACTWe empirically examine the joint predictions of the pecking order theory and the theory of time-varying asymmetric information regarding the timing of security offerings around information disclosures. We analyze loan originations and bond offerings around earnings announcements and compare them against equity offerings. In support of the theories' predictions, we find a positive association between the information sensitivity of securities and the likelihood of their issuance after earnings announcements. In particular, we find that clustering after earnings announcements is weakest in loan originations, stronger in bond offerings, and strongest in equity offerings. Also consistent with the theories, we find that the size of news in earnings announcements matters in the timing decision. We find weak evidence regarding the theories' implication that the direction of news in the announcement plays a role in the timing decision. We test and find that this latter result is partly attributable to potential costs associated with the omission of material negative information, such as litigation risk.JEL Classifications: D82; G14; G39; M41.

Private Student Loans and BAPCPA: Did Four-Year Undergraduates Benefit from the Increased Collectability of Student Loans?

Since 1976, Congress has progressively amended the bankruptcy laws to treat some types of student loans differently from other unsecured debt. In 2005, student loans originated by private companies — loans granted only to credit-worthy individuals and risk-priced at origination — were added to the list of educational loans that are presumptively nondischargeable in bankruptcy. Proponents of this change argued that it was necessary to prevent strategic borrower behavior and reduce the cost of consumer credit. Focusing on consumers’ decision-making biases, opponents predicted that there would be no discernible change in the cost of consumer credit or loan volumes. We develop and test theoretical models predicting the effects of the law change on private student loans granted to students at four-year undergraduate institutions. Using a unique dataset of private student loan originations, we test those predictions using ordinary least squares regression, Blinder-Oaxaca, matching, and difference-in-difference methods. We find that both opponents and proponents of bankruptcy reform were wrong about the effect of that reform. The overall cost of private student loans at four-year undergraduate institutions increased by an average of 35 basis points as a result of the law change. We also find that the law change caused an expansion of credit for less credit worthy borrowers, although the average borrower credit score only decreased slightly in practical terms. We attribute a 200% increase in loan volumes to the law change.

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.

Risk management–control system interplay: case studies of two banks

Purpose This paper aims to explore the interplay between risk management and control systems in banks, specifically investigating the managerial intentions underlying the design of management control systems. Design/methodology/approach This study is based on 31 interviews with personnel of two banks in a European country. Findings The main finding is that belief systems drive the interplay between risk management and control systems in the studied banks. In several instances, belief systems and boundary systems were operating complementarily. Cross-case analyses of the two banks demonstrate that risk management (i.e. the Basel II Accord) replaced established operating procedures for loan origination and portfolio monitoring at the first bank, whereas senior managers suppressed Basel II to maintain established loan origination and portfolio monitoring procedures at the second one. Originality/value This is one of very few studies investigating the interplay between risk management and control systems in banks.

Deposit Shocks and Credit Supply: Evidence from U.S. Lottery Winners

This paper investigates the impact of deposit shocks on banks’ balance sheet. The empirical strategy exploits as a natural experiment the lottery jackpot winners of Powerball and Mega Millions. Using hand-collected data, I find that the banks that receive the jackpot winner shock experience a large increase in deposits and total lending. The estimate of the elasticity of small business lending with respect to deposits is 0.876. I control for local credit demand by comparing loan origination of banks in the treatment group within a given CBSA in a given year to banks in the control group in the same CBSA-year. Consistent with frictions that originate from adverse selection, the set of small and medium-sized banks and those with the most illiquid balance sheets significantly increase loan origination after the winners’ shocks.

Bank Market Power and Firm Performance

Does market power of banks affect firm performance? To answer this question we examine 25,236 syndicated loan facilities granted between 2000 and 2010 by 296 banks to 9,029 US non-financial firms. Accounting for both observed and unobserved bank and firm heterogeneity, we find that firms that were recently poorly performing obtain loans from banks with more market power. However, in the year after loan origination market power positively affects firm performance, but only if it is not too high. Our estimates thus suggest that bank market power can facilitate access to credit by poorly-performing firms, yet at the same time also boosts the performance of the firms that obtain credit.

The Industrial Organization of the US Residential Mortgage Market

We show that the US residential single-family mortgage-origination market is highly concentrated once account is taken of the contractual coordination that arises from the correspondent- and warehouse-funding channels. We represent these channels as a network, using the flow of loans through three strata of the loan origination market: origination, aggregation, and securitization. We develop a network representation of the origination market and demonstrate that it is a small world, in that most nodes are close in the network. We then rank-order the interlinked aggregators and securitizers using ex post mortgage foreclosure rates as a proxy for performance. Our findings suggest that these significant interlinkages in the mortgage-origination network represent a previously underappreciated source of systemic risk. Many apparently atomistic mortgage underwriters are, in fact, coordinated to act in parallel because of their funding relationships with the large, too-big-to-fail bank holding companies.