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Are Securitizations in Substance Sales or Secured Borrowings? Capital-Market Evidence
Flora F. Niu and Gordon D. Richardson
Executive Summary
Asset securitization involves pooling groups of assets, such as mortgages and trade or credit card receivables, and financing them with securities that are sold to investors. Credit analysts generally adopt a secured borrowing view of securitizations and have algorithms for adjusting the balance sheet of the originator to bring the transferred assets and related off-balance-sheet (OBS) debt back on to the balance sheet. The analysts have criticized sale accounting treatment for securitization deals, arguing that most or all of the risk of the transferred assets remains with the originator. This accounting is the focus of debate among standard-setters around the globe.
Two standard-setting approaches have emerged globally to guide the choice between sale accounting and secured borrowing accounting for securitizations. The two approaches are characterized as follows: assets are derecognized on the basis of (a) transfers of control, with sale accounting applied to transferred components (control and components approach), or (b) transfer of risks and rewards, with sale accounting applied to assets for which the entity has transferred substantially all risks and rewards (risks and rewards transfer approach).
The current U.S. standard, SFAS No. 140, is based on a transfer of control (control and components approach) and adopts separate components accounting if a control transfer test is met. In contrast, the current international standard, IAS No. 39, is based primarily on an analysis of risks and rewards transfer. The international accounting standard-setting partnership (IASB, FASB, and other major national standard-setters) has identified a lack of consensus about derecognition accounting as a major impediment to achieving convergence in global standards that must be resolved. Thus, both SFAS No. 140 and IAS No. 39 will be reexamined and we will present timely evidence that is pertinent to the issues to be debated.
In this study, we present evidence consistent with the notion that originators, on average, retain most, if not all, of the risks related to the transfer of receivables. Specifically, for a sample of originators applying the sale accounting guidance in SFAS No. 125 and SFAS No. 140 during the period 1997–2003, we show that OBS debt related to securitizations has, on average, the same risk-relevance for explaining market measures of risk (that is, CAPM beta) as on-balance-sheet debt. This is consistent with the view of credit-rating analysts, who view many securitizations as, in substance, secured borrowings.
We also present additional evidence supporting the above findings: in a returns and earnings association framework, the pricing multiple for securitization gains declines as the amount of OBS debt increases, implying that investors take OBS debt into account when assessing the valuation-relevance of such gains. It would appear that the put option arising from implicit recourse (that is, the obligation to absorb losses up to the full amount of transferred assets, in order to protect reputation) is a “missing piece” that is not accounted for by the frequent securitizers in our sample when they calculate securitization gains.
Related concurrent studies on securitization accounting using SFAS No. 125 samples and one study using an SFAS No. 140 sample hypothesize and find evidence consistent with originators using the discretion afforded by SFAS No. 125/140 to value-retained interests in an opportunistic manner to achieve earnings-management objectives. These studies thus point to problems with the control and components approach that relies heavily on reliable fair value estimates of components sold and retained. The above evidence, when combined with our OBS debt evidence, challenges the extant measurement standards in SFAS No. 140.