Works of Friction? Originator-Sponsor Affiliation and Losses on Mortgage-Backed Securities

56 Pages Posted: 16 Mar 2011

See all articles by Cem Demiroglu

Cem Demiroglu

Koc University, College of Administrative Sciences and Economics

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: January 21, 2011

Abstract

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

Demiroglu, Cem and James, Christopher M., Works of Friction? Originator-Sponsor Affiliation and Losses on Mortgage-Backed Securities (January 21, 2011). AFA 2012 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1787813 or http://dx.doi.org/10.2139/ssrn.1787813

Cem Demiroglu (Contact Author)

Koc University, College of Administrative Sciences and Economics ( email )

Koc University
Sariyer
Istanbul, 34450
Turkey
90-212-338-1620 (Phone)
90-212-338-1653 (Fax)

HOME PAGE: http://https://sites.google.com/site/cemdemiroglu/

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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