SSRN-id1107074

Electronic copy available at: http://ssrn.com/abstract=1107074

Asset Sales, Recourse, and Investor Reactions to InitialSecuritizations: Evidence why Off-balance Sheet AccountingTreatment does not Remove On-balance Sheet Financial Risk

by

Eric J. Higgins

1

, Joseph R. Mason

2*

, and Adi Mordel

3

May 15, 2009Abstract

Both accounting and regulatory treatments classify securitizations as a “sale” of assets,therefore allowing the issuer to remove the assets from their books. This “off-balance sheet”treatment relies crucially on the concept of “true” sale. The concept most diametrically opposed from a true sale is a “financing.” In a financing, assets do not leave the firm’s books, so thetransaction is exclusively “on-balance sheet.” The present paper presents conjectural evidenceof recourse activity and bankruptcy seizure that undermine the fundamental concept of true sale.The paper then analyzes investor reactions to firms’ first securitization announcements,demonstrating negative short-term equity returns and negative long-term operating performance following initial securitizations. Such reactions constitute evidence that securitizations are moresimilar to financings than asset sales. Additional analysis shows that securitization is alsoassociated with increased systematic risk, suggesting that the rapid growth fueled bysecuritization is similar to increasing leverage. The effect is more pronounced for banks thannon-banks, suggesting that there is substantial value to regulatory capital arbitrage in additionto accounting arbitrage.Keywords:

Bank Regulation; Securitization; Off-balance Sheet; Recourse; Bankruptcy-remote

JEL classification:

G21; G28 _________________________

The authors are:

1

von Waadn Professor of Investment Management, Kansas State University;

2

Hermann Moyse,Jr./Louisiana Bankers Association Professor of Banking, Louisiana State University and Senior Fellow, the WhartonSchool; and

3

Drexel University.The authors wish to thank seminar participants at the Federal Reserve Bank of New York, the Federal Reserve Bank of Philadelphia, the Federal Reserve Board, and Drexel University, Kansas State University, and Louisiana StateUniversity and attendees at the Financial Management Association and the MARC Research Conference atVillanova University for useful comments and criticism. The authors extend specific thanks to Charles Calomiris,Gregory Elliehausen, Gary Gorton, Robert Hunt, Kose John, Andrew Kish, Dalia Marciukaityte, Eli Ofek, andAnnette Poulson for general comments and guidance. All remaining errors are our own.*Contact author: Joseph R. Mason. Contact information: joseph.r.mason@gmail.com; (202) 683-8909 of. CopyrightJoseph R. Mason, 2009. All rights reserved.

Electronic copy available at: http://ssrn.com/abstract=1107074

Asset Sales, Recourse, and Investor Reactions to InitialSecuritizations: Evidence why Off-balance Sheet AccountingTreatment does not Remove On-balance Sheet Financial Risk

May 15, 2009Abstract

Both accounting and regulatory treatments classify securitizations as a “sale” of assets,therefore allowing the issuer to remove the assets from their books. This “off-balance sheet”treatment relies crucially on the concept of “true” sale. The concept most diametrically opposed from a true sale is a “financing.” In a financing, assets do not leave the firm’s books, so thetransaction is exclusively “on-balance sheet.” The present paper presents conjectural evidenceof recourse activity and bankruptcy seizure that undermine the fundamental concept of true sale.The paper then analyzes investor reactions to firms’ first securitization announcements,demonstrating negative short-term equity returns and negative long-term operating performance following initial securitizations. Such reactions constitute evidence that securitizations are moresimilar to financings than asset sales. Additional analysis shows that securitization is alsoassociated with increased systematic risk, suggesting that the rapid growth fueled bysecuritization is similar to increasing leverage. The effect is more pronounced for banks thannon-banks, suggesting that there is substantial value to regulatory capital arbitrage in additionto accounting arbitrage.Keywords:

Bank Regulation; Securitization; Off-balance Sheet; Recourse; Bankruptcy-remote

JEL classification:

G21; G28

Electronic copy available at: http://ssrn.com/abstract=1107074

1Securitization is based on the concept of a “true” sale. As originally envisaged under FASB140, the sale leaves no remaining link to the sponsor (or seller) whether through the possibility that the assets will be repurchased or guaranteed or that they will be available togeneral creditors of the firm in bankruptcy.In practice, however, securitizations closely resemble typical firm financingarrangements. In the real world, sponsors of securitized assets maintain representations andwarranties, servicing contracts, and repeated reliance on a relatively small market of buyers for future securitizations (monopsonistic qualities in a repeated game) that continually link buyer and seller, possibly precluding the sort of true sale originally envisaged under FASB140. Eventhe most fundamental concept of the “bankruptcy remoteness” principal by which the buyer hasfull title to the collateral has fared poorly before bankruptcy courts and now stands on the vergeof being ruled irrelevant. In a financing, the assets do not leave the firm’s books so thetransaction is exclusively on-balance sheet. Important covenants related to the financing aredisclosed and the assets used in the financing are always at risk of consolidation into the generalestate by bankruptcy judges.Both accounting and regulatory treatments classify securitizations as a sale of assets,allowing the issuer to remove the assets from their books and receive off-balance sheettreatment. But the debate continues regarding whether securitizations are sales or financings, andmore fundamentally, whether they should be carried on- or off-balance sheet.One way to distinguish whether securitizations are sales of financings from a financial-economics perspective is to examine how investors in the sponsor firm, themselves, react tosecuritizations. In such an exercise, the most important information about investor reactions lies

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