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Incentives and tranche retention in securitisation: a screening model

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  • Ingo Fender
  • Janet Mitchell

Abstract

This paper examines the power of different contractual mechanisms to influence an originator’s choice of costly effort to screen borrowers when the originator plans to securitise its loans. The analysis focuses on three potential mechanisms: the originator holds a “vertical slice”, or share of the portfolio; the originator holds the equity tranche of a structured finance transaction; the originator holds the mezzanine tranche, rather than the equity tranche. These mechanisms will result in differing levels of screening, and the differences arise from varying sensitivities to a systematic risk factor. Equity tranche retention is not always the most effective mechanism, and the equity tranche can be dominated by either a vertical slice or a mezzanine tranche if the probability of a downturn is likely and if the equity tranche is likely to be depleted in a downturn. If the choice of how much and what form to retain is left up to the originator, the retention mechanism may lead to low screening effort, suggesting a potential rationale for government intervention.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 289.

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Length: 43 pages
Date of creation: Sep 2009
Date of revision:
Handle: RePEc:bis:biswps:289

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Keywords: retention requirements; screening incentives; securitisation; tranching;

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References

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  1. Ingo Fender & Nikola Tarashev & Haibin Zhu, 2008. "Credit fundamentals, ratings and value-at-risk: CDOs versus corporate exposures," BIS Quarterly Review, Bank for International Settlements, March.
  2. Dewatripont, Mathias & Legros, Patrick & Matthews, Steven A, 2002. "Moral Hazard and Capital Structure Dynamics," CEPR Discussion Papers 3487, C.E.P.R. Discussion Papers.
  3. Jan Pieter Krahnen & Christian Wilde, 2006. "Risk Transfer with CDOs and Systemic Risk in Banking," CFS Working Paper Series 2006/04, Center for Financial Studies.
  4. Parlour, Christine & Plantin, Guillaume, 2008. "Loan Sales and Relationship Banking ," Open Access publications from University of Toulouse 1 Capitole http://neeo.univ-tlse1.fr, University of Toulouse 1 Capitole.
  5. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
  6. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
  7. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1992. "Risk Management: Coordinating Corporate Investment and Financing Policies," NBER Working Papers 4084, National Bureau of Economic Research, Inc.
  8. Darrell Duffie, 2008. "Innovations in credit risk transfer: implications for financial stability," BIS Working Papers 255, Bank for International Settlements.
  9. Chiesa, Gabriella, 2008. "Optimal credit risk transfer, monitored finance, and banks," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 464-477, October.
  10. Alan D. Morrison, 2005. "Credit Derivatives, Disintermediation, and Investment Decisions," The Journal of Business, University of Chicago Press, vol. 78(2), pages 621-648, March.
  11. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  12. Ingo Fender & Janet Mitchell, 2005. "Structured finance: complexity, risk and the use of ratings," BIS Quarterly Review, Bank for International Settlements, June.
  13. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  14. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  15. Adam B. Ashcraft & Til Schuermann, 2008. "Understanding the securitization of subprime mortgage credit," Staff Reports 318, Federal Reserve Bank of New York.
  16. Alan Morrison, 2000. "Credit Derivatives, Disintermediation and Investment Decisions," OFRC Working Papers Series 2001fe01, Oxford Financial Research Centre.
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Citations

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Cited by:
  1. Abraham, Filip & Van Hove, Jan, 2010. "Can Belgian firms cope with the Chinese dragon and Asian tigers? The export performance of multi-product firms on foreign markets," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/330214, Katholieke Universiteit Leuven.
  2. Gürtler, Marc & Hibbeln, Martin, 2012. "How smart are investors after the subprime mortgage crisis? Evidence from the securitization market," Working Papers IF39V1, Technische Universität Braunschweig, Institute of Finance.
  3. Bobek, Andreas & Bohm, Thomas & Neuner, Stefan & Paintner, Sandra & Schmeußer, Stefanie & Waldvogel, Felix, 2011. "Ökonomische Analyse europäischer Bankenregulierung: Verbriefung und Interbankenmarkt im Fokus," Bayreuth Working Papers on Finance, Accounting and Taxation (FAcT-Papers) 2011-01, University of Bayreuth, Chair of Finance and Banking.
  4. Andrew B. BERNARD & Emily J. BLANCHARD & Ilke VAN BEVEREN & Hylke Y. VANDENBUSSCHE, 2012. "Carry-Along Trade," Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) 2012020, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
  5. Pagès, H., 2009. "Bank incentives and optimal CDOs," Working papers 253, Banque de France.
  6. Scholz, Julia, 2011. "Manager- und transaktionsspezifische Determinanten der Performance von Arbitrage CLOs," Discussion Papers in Business Administration 12144, University of Munich, Munich School of Management.
  7. Kiff, John & Kisser, Michael, 2011. "A Shot at Regulating Securitization," Discussion Papers 2011/7, Department of Finance and Management Science, Norwegian School of Economics.
  8. Allen B Frankel, 2009. "The risk of relying on reputational capital: a case study of the 2007 failure of New Century Financial," BIS Working Papers 294, Bank for International Settlements.
  9. Bernard, Andrew B & Van Beveren, Ilke & Vandenbussche, Hylke, 2010. "Multi-product exporters, carry-along trade and the margins of trade," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/382740, Katholieke Universiteit Leuven.
  10. Sara Malekan & Georges Dionne, 2012. "Securitization and Optimal Retention under Moral Hazard," Cahiers de recherche 1221, CIRPEE.
  11. Spiros Bougheas, 2012. "Pooling, Tranching and Credit Expansion," CESifo Working Paper Series 3859, CESifo Group Munich.

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