Works of Friction? Originator-Sponsor Affiliation and Losses on Mortgage-Backed Securities
56 Pages Posted: 16 Mar 2011
Date Written: January 21, 2011
This paper examines how originator risk retention is related to the structure, pricing, and performance of securitized pools of residential mortgages created during the 2003-2007 period. We argue that originator risk retention is likely to vary positively with originator-sponsor and originator-servicer affiliation. We refer to the lack of affiliation as measures of distance-from-loss. Overall, we find that, after controlling for borrower and deal characteristics, cumulative net loss and foreclosure rates are significantly higher for mortgage-backed securities (MBS) in which originators are not affiliated with the sponsor or servicer (i.e., the loss distance is greater). We also find that the losses and foreclosures occur earlier in MBS with greater distance-from-loss. Consistent with screening being more important for loans with limited or no documentation (low-doc) than full documentation loans, we find that affiliation is related to loan performance only in the case of low-doc loans. Moreover, we find that the distance was also related to losses before the peak of the housing market. Consistent with investors recognizing the potential loss exposure from greater distance-from-loss, we find that the average yield spreads are higher on MBS with greater distance. Consistent with the performance results, we find a positive relation between yields and distance from loss only for deals that consist primarily of low-doc loans. We also find that the percentage of AAA-rated securities issued against the mortgage pool is decreasing in the distance. Finally, deals with greater distance are significantly more likely to employ overcollateralization accounts (that require the sponsor to have greater skin in the game). These results suggest that, while ex post investors might have misestimated their exposure to losses arising from incentive conflicts with the originator, ex ante frictions were reflected (at least in part) in the pricing and the structure of MBS.
Keywords: securitization, MBS, skin in the game, liar's loans
JEL Classification: G21
Suggested Citation: Suggested Citation