Sponsor Risk and the Performance of Asset-Backed Securities
44 Pages Posted: 25 Aug 2011
Asset-backed securitization transforms assets into securities and in the process separates the credit risk of a pool of assets from the credit risk of the securitization’s sponsor, which gives securitization several important advantages over issuing corporate debt. Recent research, however, suggests a link between the financial condition of the sponsor and the performance of its ABS. If market participants do not fully understand the link between the sponsor’s financial condition and the future performance of its ABS, rating agencies may improperly rate these securities, investors may improperly price the risk of these securities, and regulators may require inadequate capital against potential losses in these securities. The results presented in this paper suggest a strong link between the financial condition of the sponsor and the subsequent performance of the securitization. Securities sponsored by a higher-rated sponsor retain their initial rating longer before being downgraded than securities sponsored by a lower-rated sponsor. Securities sponsored by better capitalized, more diversified, or vertically integrated firms also perform better. Finally, securities sponsored by banks tend to be downgraded later than ABS sponsored by foreign banks or by nonbanks. Importantly, we find many of these relationships existed in ABS issued well before the financial crisis.
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