Interaction between Securitization Gains and Abnormal Loan Loss Provisions: Credit Risk Retention and Fair Value Accounting

• In Event: Banking

Abstract

I investigate whether managers use gains from asset securitizations to substitute or complement loan loss provision (LLP) management for smoothing earnings in the financial industry. Dechow et al. (2010) provide evidence that managers have used securitization transactions to either boost or smooth earnings. I provide evidence that gains from asset securitizations are positively (negatively) associated with abnormal LLP when the percentage of credit risk retention of the securitized assets is greater (less) than one percent. Further, I find that managers use the securitization gains neither to substitute nor complement abnormal LLPs for banks only securitizing mortgages. This evidence is consistent with the conjecture that, because the market for mortgage backed securities is significantly larger and substantially more liquid relative to the other types of securitized loans, less discretion is available for bank managers to provide biased estimates of fair values of retained interests to smooth earnings.

Author

• Qiuhong Zhao, Texas A&M University - Corpus Christi