The Agency Costs of (RMBS) Tranching

Abstract

The tranching of cash flows from an asset pool into multiple securities with varying priorities worsens agency frictions between investors and the asset manager. This paper shows that agents managing subprime residential mortgages on behalf of mortgage backed security investors were less likely to renegotiate delinquent loans from pools which collateralized both a higher number of tranches, and tranches with more varied seniorities. Agents particularly pull back from renegotiating loans that require more of their costly effort. We rule out key alternative explanations such as loan pool credit quality, and agent skill and capacity. Overall, our results highlight the potential costs of multi-tiered capital structures.

Keywords: Capital Structure, Securitization, Mortgages, Asymmetric Information

JEL Classification: G21, G23, G32, D82