Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness

Abstract

This paper focuses on a key property of asset-backed securities (ABS); namely, that ABS are designed to achieve bankruptcy remoteness of the securitized assets from the borrowing firm. This provides lenders with maximal protection from dilution in bankruptcy that is not available with other contracts, such as secured debt. ABS can have real effects in allowing firms to commit to more efficient investment decisions in bankruptcy. We show that securitization of replaceable assets, such as accounts receivable, prevents inefficient continuation in bankruptcy, but securitization of necessary assets can lead to inefficient liquidations. In these circumstances, secured debt and/or leases can be preferred.

We provide empirical support for the importance of bankruptcy remoteness in ABS contracts using a controversial decision in the Chapter 11 bankruptcy of LTV Steel, in which a securitization contract was unexpectedly treated as a secured loan. Using a difference-in-differences approach, we find that ABS spreads for securitizers eligible for Chapter 11 increased significantly more than spreads for insured bank securitizers, who are not Chapter 11-eligible, in the period following the LTV filing. The results demonstrate that the creditor protection provided by bankruptcy remoteness is indeed valuable and priced in financial markets.

Keywords: asset-backed securities, securitization, bankruptcy, Chapter 11, capital structure, secured debt, leases

JEL Classification: G21, G32, G33, G38, K00