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

Abstract

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.

Keywords: Securitizations, loans, banks, risk, retained interests, implicit recourse

JEL Classification: G21, G32, M41