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Asset securitization, information asymmetry, and insider trading

Asset securitization, information asymmetry, and insider trading . Ying Zhou Jennifer Wu Tucker June 2011. Research Question. Do insiders take advantage of the information problem related to asset securitizations?. Terminology. Asset securitization Recourse

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Asset securitization, information asymmetry, and insider trading

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  1. Asset securitization, information asymmetry, and insider trading Ying Zhou Jennifer Wu Tucker June 2011

  2. Research Question • Do insiders take advantage of the information problem related to asset securitizations?

  3. Terminology • Asset securitization • Recourse • Explicit recourse (retained interest) • Implicit recourse • Risk transfer • Information asymmetry • Bid-ask spreads • Analyst disagreement • Insider trading

  4. Asset securitization • “Assets”: financial assets of a company (say, bank), such as mortgage loan receivables, other consumer loan receivables, and commercial loan receivables • Securitization: the company sells a pool of assets to a special purpose entity (SPE), where the SPE raises cash to purchase the assets by selling debt securities to investors

  5. Asset Securitization

  6. Economic benefits of asset securitization • Better asset portfolio diversification • Higher level of liquidity • Lower leverage indicated by the balance sheet • Lower cost of capital because the SPE can typically raise funds at a lower rate due to lower expected bankruptcy cost

  7. Recourse • ABS investors are concerned that the original loan receivables may go bad • The originating bank (issuer) provides some types of guarantees. Such guarantees are called “recourse.” Also referred to as “credit enhancement tools” • Explicit recourse: contractual. Retain the lowest tranch of the asset-backed debt securities • Implicit recourse: not obligated but expected

  8. Therefore, securitizations • Delink and repackage the risk and value of the securitized assets • securitized assets=transferred interests + retained interests • retained interests that concentrate the credit and other risks of the securitized assets are similar to derivatives • A securitization has features of both a sale of the assets and a secured borrowing through the debt securities issued by the SPE • The pool of securitized assets varies, the types of debt securities vary, and the recourse terms vary from securitization to securitization – very complex!

  9. Financial reporting and disclosure of asset securitizations • Financial reporting approaches: • Control and component approach: SFAS 140 and 156 • Risk and reward approach: IAS 39 • Companies prefer sale accounting rather than secured-borrowing accounting • Disclosure: • The concern was “inadequacy” • New reporting and disclosure requirement: • SFAS 166 and 167 since 2010 Q1

  10. Information uncertainty and information asymmetry • The information uncertainty is regarding the amount and the extent of risk transfers in a securitization • Serious information asymmetry between insiders and outside investors, even if the outside investors are sophisticated institutions

  11. Opportunities for insider trading • Cheng et al. (2011 TAR) find that high information uncertainty at securitizing banks • Bid-ask spreads • Analyst disagreement • Insiders are in the best position to understand the implications of the securitizations to the bank • Insiders are top managers, directors, and large investors of ownership of at least 10%

  12. Data • U.S. bank holding companies • 2001Q2 to 2007Q2: 25 quarters • Accounting data from the regulatory Y-9C reports that BHCs file quarterly with the Federal Reserve • Returns data from CRSP • Insider trading data from Thomson Financial

  13. Empirical design Log(ISTRADE) = a0 + a1SECURITIZE + a2SIZE + a3TURNOVER + a4|ΔROA| + a5logMB + a6PASTRET + a7FUTURERET + e Dependent variables also use ISPURCH and ISALLTRADE Explanatory variables, SECURITIZE, are: (1) SAD (2) SA (3) SMA, SCONA, and SCOMA

  14. Descriptive statistics

  15. Primary analysis

  16. Conclusion • Although financial products facilitate risk transfers and resource allocations in the capital markets, some are extremely complex and existing financial reporting and disclosure are innately inadequate • The opaqueness provides company insiders opportunities to benefit from their timely private information • We find that insiders are unusually active at banks with active asset securitization activities, suggesting that a consequence of using such a financial engineering vehicle is to open doors for insider trading

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