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Why do banks securitize loans?

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Securitization without risk transfer? Spanish system Performance of banks that set up bigger SPVs Securitization methods Pass through securitizations ... – PowerPoint PPT presentation

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Title: Why do banks securitize loans?


1
Why do banks securitize loans?
  • More efficiently use expensive capital
  • Regulatory capital arbitrage
  • SPV with credit enhancement versus retaining the
    loans in the portfolio
  • 1/10 capital requirement
  • Credit enhancement liquidity enhancement?
  • Securitization without risk transfer?
  • Spanish system
  • Performance of banks that set up bigger SPVs

2
Securitization methods
  • Pass through securitizations (no credit
    enhancement, no layering)
  • CDOs (magic of diversification? whats the idea
    behind tranching ABS?)
  • ABCP conduits (securitization without risk
    transfer?)

3
Whats wrong with tranching?
  • Default correlations are ignored
  • Example A mortgage pool with 2 loans each with a
    face value of 1 and default probability of 10.
    Two investors each invest 1, one buys the senior
    tranche the other one buys the junior tranche.
  • If defaults are uncorrelated, default probability
    of the senior tranche 1.
  • If defaults are perfectly correlated, default
    probability of the senior tranche 10.

4
Securitization and bank incentives
  • Securitization reduces banks incentive to
    properly screen and monitor their borrowers
  • However, this cannot explain the large losses
    banks took during the crisis
  • 39 of securitized loans were sitting on banks
    balance sheets as of June 2008

5
The role of rating agencies
  • 44 of Moodys revenues in 2006 came from rating
    structured finance products
  • 27 out of 30 AAA-rated CDOs underwritten by
    Merrill were downgraded to junk within a year
  • Illusion of comparability of corporate bond (1
    AAA) and CDO ratings (60 AAA)
  • Barely enough to obtain a AAA rating

6
Agency problems at rating agencies?
  • One analyst expressed concern that her firms
    model did not capture half of the deals risk,
    but that it could be structured by cows and we
    would rate it
  • An analytical manager in the same rating agency
    Lets hope we are all wealthy and retired by the
    time this house of cards falters.

7
Or is it ignorance?
  • CEO of First Pacific Advisors on the phone with
    an associate at Fitch
  • FPC What are the key drivers of your rating
    model?
  • Fitch FICO scores and home price appreciation
    of low single digit or mid single digit, as home
    price appreciation has been for the last 50
    years.
  • FPC What if home price appreciation was flat
    for an extended period of time?
  • Fitch Our model would start to break down.
  • FPC What if home prices decline 1 to 2 for an
    extended period of time?
  • Fitch The models would break down completely.
  • FPC With 2 depreciation, how far up the
    ratings scale would it harm?
  • Fitch It might go as high as the AA or AAA
    tranches.
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