Ebook Asset Securitizations and Credit Risk
This study seeks to determine the sources of credit risk associated with asset securitizations and whether credit rating agencies and the bond market differ in their perception of the sources of this risk. We focus on credit risk because the transfer of credit risk is a key motivation for asset securitizations and it raises difficult accounting issues. By addressing whether perceptions of credit risk differ for credit rating agencies and the bond market, we provide evidence on critics’ allegations that rating agencies were not diligent in assessing the effects of “off-balance sheet” activities, particularly asset securitizations, when developing credit ratings. We find that asset securitizations are positively associated with the securitizing firm’s credit risk, but credit rating agencies and the bond market differ in their perception of the sources of this risk.
In a typical securitization transaction, a firm transfers assets to a special purpose securitization entity (SPE) and, in exchange, receives cash obtained from other investors in the SPE and a retained interest in the transferred assets. Because the firm’s continuing involvement with the securitized assets can be complex, it is not straightforward to determine whether all of the risk of the assets resides with the SPE, all of the risk of the assets resides with the firm, or whether some of the risk of the assets resides with the SPE and some with the firm.
Consistent with this lack of clarity, there is an ongoing debate regarding the appropriate accounting treatment for asset securitizations. Accounting standards relating to asset securitizations specify conditions that must be met for a securitization transaction to be treated as a sale. Under the current accounting rules, for a securitization to receive sale treatment, the risk of the assets must be completely transferred to the SPE. If the risk transfer is incomplete, i.e., some or all of the risk resides with the securitizing firm, the securitization is treated as secured borrowing. Recently, however, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have revisited the accounting for securitizations because the boards believe it is not always clear whether transfers of assets, particularly to securitization entities, are sales or borrowings, and whether such a distinction faithfully represents the economics of the transactions (FASB, 2009; IASB, 2009). We provide insight into the ongoing financial reporting controversy relating to asset securitizations by providing evidence on the extent to which securitized assets are associated with the firm’s credit risk, and whether credit market participants view securitizations as sales or borrowings.
Our tests focus on the relation between two measures of credit risk—credit ratings and bond spreads—and accounting amounts related to asset securitizations of bank holding companies. We focus on banks because they are the largest group of asset securitizers and data on their securitizations are available from the Federal Reserve. Using both credit ratings and bond spreads enables us to provide evidence on whether the perceptions of the sources of credit risk associated with asset securitizations differ for two key credit market participants. Comparing the results from the two sets of tests provides insight into allegations that credit rating agencies were not diligent in assessing the effects of securitizations on credit risk.
We estimate the relation between the firm’s credit risk and both total securitized assets and the firm’s retained interest in the securitized assets. We first use credit ratings as the measure of credit risk. If rating agencies perceive that the firm does not bear the risk of the assets transferred to the SPE and only bears the risk of its retained interest, we expect to observe no relation between credit ratings and total securitized assets and a positive incremental relation between credit ratings and the firm’s retained interest. Such a finding is consistent with credit rating agencies viewing securitizations as asset sales. This could be the case, for example, if rating agencies view the SPE as separate from the firm, i.e., as bankruptcy remote. If, instead, credit rating agencies perceive that the firm bears risk associated with assets transferred to the SPE, we expect to observe a positive relation between credit ratings and total securitized assets. Such a finding indicates that rating agencies view both the retained and non-retained portions of the securitized assets as relevant to the firm’s credit risk. Finding, both a positive relation between credit ratings and total securitized assets and no incremental relation for the firm’s retained interest indicates that rating agencies do not distinguish between the retained and non retained portions when assessing the firm’s credit risk. Such a finding is consistent with rating agencies viewing asset securitizations as secured borrowings. We then use bond spreads as the measure of credit risk, and interpret the findings from this relation in the same way as we interpret the credit rating relation.
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