The Market’s View on Accounting Classifications for Asset Securitizations

Dissertation

Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University

By

Minkwan Ahn, M.Acc.

Graduate Program in Accounting & MIS

The Ohio State University

2014

Dissertation committee:

Anne Beatty, Advisor

Darren Roulstone

Andrew Van Buskirk

Haiwen Zhang

Copyright by

Minkwan Ahn

2014

Abstract

Prior research examines how investors view asset securitizations, and shows that investors treat securitizations as borrowings even when GAAP treats them as sales. Upon the adoption of two new accounting standards relating to asset securitizations, some off- balance-sheet securitized assets were consolidated back onto firms’ balance sheets. This study examines whether the new accounting standards result in financial reporting that is more aligned with investors’ views of asset securitizations. To address this question, this study investigates how investors viewed previously off-balance-sheet securitized assets before the two new standards became effective. In doing so, it separately examines assets that firms consolidated under the new standards and those that firms left unconsolidated. I find that investors differentiated between these two types of securitizations, treating the consolidated assets as borrowings and the unconsolidated assets as sales. I conclude that the new accounting standards are more consistent with equity investors’ views of asset securitizations.

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Acknowledgments

For its guidance and support on this study, I thank my dissertation committee: Anne

Beatty (Chair), Darren Roulstone, Andrew Van Buskirk, and Haiwen Zhang. I also thank

Samuel Bonsall, Michael Iselin, Bret Johnson, Allison Nicoletti, and Austin Sudbury as well as workshop participants at The Ohio State University, University of Hong Kong,

Hong Kong University of Science and Technology, Chinese University of Hong Kong,

City University of Hong Kong, Hong Kong Polytechnic University, Seoul National

University, and Korea Advanced Institute of Science and Technology for helpful comments and suggestions. I gratefully acknowledge financial support from the Fisher

College of Business.

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Vita

April 2008…………………………………B.S. Accounting, Brigham Young University

April 2008…………………………………M.A. Accounting, Brigham Young University

2009 to present…………………………….Graduate Research Assistant, Accounting &

MIS, The Ohio State University

Fields of Study

Major Field: Accounting & MIS

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Table of Contents

Abstract.…………………………………………………………………………………..ii

Acknowledgments………………………………………………………………………..iii

Vita...... …………………………………………………………………………………..iv

List of Tables…………………………………………………………………………….vii

Chapter 1. Introduction...... 1

Chapter 2. Background on Asset Securitizations...... 13

2.1 Typical Structure of Asset Securitizations...... 13

2.2 Accounting for Asset Securitizations...... 14

2.2.1 SFAS 140 and FIN 46(R)...... 14

2.2.2 SFAS 166 and SFAS 167...... 17

Chapter 3. Related Literature Review...... 20

Chapter 4. Hypotheses Development...... 25

Chapter 5. Research Design...... 28

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5.1 Tests of H1 - H3...... 33

5.2 Tests of H4...... 38

Chapter 6. Sample and Descriptive Statistics...... 40

Chapter 7. Results...... 43

7.1 Tests of H1 - H3...... 43

7.2 Tests of H4...... 45

Chapter 8. Robustness Tests...... 48

Chapter 9. Conclusion...... 51

References...... 54

Appendix A: Accounting Standards for Asset Securitizations...... 58

Appendix B: 10-K Filings Examples - Impact of SFAS 166 and SFAS 167...... 59

Appendix C: Variable Definitions...... 60

Appendix D: Sample Selection Procedures...... 62

Appendix E: Tables...... 63

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List of Tables

Table 1. Descriptive Statistics……………………………………………………...……63

Table 2. Distribution of Estimated SPE Assets (EST_Securitized)...... …………66

Table 3. Relation between Equity Risk (σR) and QSPE and VIE Assets……………...... 67

Table 4. Relation between Equity Risk (σR) and Estimated SPE Assets

(EST_Securitized)...... 68

Table 5. Relation between Estimated SPE Assets (EST_Securitized) and Consolidated

Securitized Assets (CONS_Securitized)...... …………...... 69

Table 6. Relation between Equity Risk (σR) and QSPE and VIE Assets beyond the Type of Assets...... 70

Table 7. Relation between Equity Risk (σR) and QSPE and VIE Assets Using Other

Deflators...... 72

Table 8. Relation between Equity Risk (σR) and QSPE and VIE Assets beyond Influential

Observations...... 74

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Chapter 1. Introduction

Asset securitizations are a large source of financing for firms, especially for banks.

Banks that securitize assets are typically among the largest banks. Securitizing banks make up 83% of total assets for all banks. Barth et al. (2012) report that the size of the median securitizing bank is over $40 billion in assets. Among securitizing banks, Barth et al. (2012) report that securitized assets constitute on average 20% of the banks’ total assets. Securitization transactions are accounted for as either sales or secured borrowings and many of the transactions are treated as sales under GAAP. However, various groups including financial analysts and investors argued that these transactions should be considered borrowings because firms may retain significant risk in securitized assets transferred to special purpose entities (SPEs) by providing implicit (i.e., non-contractual) recourse on the assets.

To provide insight into the ongoing controversy over the accounting for asset securitizations, prior research examines how investors view asset securitizations, and indicates that investors assume that on average firms will provide implicit recourse on securitized assets (Niu and Richardson 2006; Landsman et al. 2008; Chen et al. 2008;

Barth et al. 2012). Concerns about implicit recourse became apparent during the recent

1 financial crisis.1 These concerns led the Financial Accounting Standards Board (FASB) to issue two new accounting standards, SFAS 166 and SFAS 167, resulting in firms bringing some of their off-balance-sheet securitized assets back onto their balance sheets.

This study examines whether the two new accounting standards result in financial reporting that is more aligned with investors’ views of asset securitizations. To address this question, this study investigates how investors viewed previously off-balance-sheet securitized assets before the new standards became effective. In doing so, it separately examines assets that firms consolidated under the new standards and those that firms left unconsolidated. Then, extending prior research, this study also examines whether, for assets consolidated under the new standards, investors distinguished between securitizations going through two different accounting structures prior to the adoption of the new standards.2 By addressing whether the new accounting standards are more consistent with investors’ views of asset securitizations, this study provides evidence on the relative effectiveness of the new accounting standards to the old accounting standards at identifying implicit recourse.3

In a typical securitization transaction, a firm transfers pools of financial assets such as mortgages and credit card receivables into an SPE that finances the acquisition of these assets by issuing debt securities. Because the securitizing firm knows more about the credit risk of the transferred assets, the firm usually provides some form of recourse

1 Two well-known examples of securitizing firms providing implicit recourse are that in 2007 HSBC Holdings and Citigroup bailed out their SPEs, bringing onto their balance sheets $45 billion and $49 billion of the SPE assets that had been accounted for as sales (The Economic Times 2007; Sidel 2007). 2 Throughout the paper, I use the term “consolidated assets” (“unconsolidated assets”) to refer to securitized assets that had been treated as sales under old accounting standards, SFAS 140 and FIN 46(R), but were (were not) consolidated under new accounting standards, SFAS 166 and SFAS 167. 3 I use the term more effective to describe the accounting that is more likely to identify securitizations to which the securitizing firm will likely provide implicit recourse. 2 to the SPE investors to protect them against potential future losses from these assets. A common feature of securitizations is that the securitizing firm retains first-loss interests in the transferred assets by holding the most junior asset-backed securities issued by the

SPE. Because explicit guarantees to the SPE violate accounting rules allowing sale accounting, the securitizing firm may instead provide implicit recourse to its troubled securitizations to make up some portion of the losses not covered by the retained interest in securitized assets.4 5 The possible presence of implicit recourse makes it difficult for investors to assess the extent of the risk retained. This is because implicit recourse was neither disclosed nor recognized in the financial statements under the old accounting standards and the securitizing firm may or may not honor its implicit commitments at its discretion. Therefore, to assess the extent of the risk retained by the securitizing firm, investors should estimate the likelihood and extent of the firm providing implicit recourse.

Prior to 2010, firms were able to keep securitized assets off their balance sheets using either qualifying special purpose entity (QSPE) or variable interest entity (VIE) accounting. QSPE and VIE accounting were allowed under SFAS 140 and FIN 46(R), respectively. QSPE accounting focused on ensuring that the securitizing firm had relinquished control over the assets, while VIE accounting emphasized the extent that the firm had retained risks and rewards from the assets. In the wake of the recent financial

4 In 2002, the Federal Financial Institutions Examination Council (FFIEC) released a list of four major actions that can signal implicit recourse: (1) selling assets to the SPE for less than their fair value, (2) purchasing assets from the SPE at a price greater than their fair value, (3) exchanging better quality assets (i.e., performing assets) for worse quality assets (i.e., non-performing assets), and (4) providing recourse or other credit enhancement beyond contractual requirements. 5 Following Barth et al. (2012), I use the term “retained interest” to refer to the portion of securitized assets that the securitizing firm retains and recognizes as the interest. I also use the term “non-retained interest” to refer to the portion of securitized assets that the firm treats as sold to SPEs. The sum of retained and non- retained interest is the total securitized assets. 3 crisis, regulators and the FASB expressed serious concerns about whether QSPE and VIE accounting properly captured implicit recourse associated with asset securitizations

(PWG 2008; Emmons 2010; FASB 2009a; FASB 2009b). To improve the transparency of securitization transactions, the FASB issued two new standards, SFAS 166 and SFAS

167, in 2009. Among other things, SFAS 166 eliminates the QSPE exemption from applying VIE accounting, and SFAS 167 replaces the quantitative analysis required under

FIN 46(R) with a qualitative analysis.6 As such, all QSPEs and VIEs in existence upon the adoption of the new standards had to be evaluated for the consolidation of VIEs in accordance to SFAS 167. As a result, some of the QSPE and VIE assets that had been treated as sales under the prior QSPE/VIE accounting were consolidated back onto firms’ balance sheets as required by the new VIE accounting.

Regulators and the FASB believe that the new VIE accounting is more effective at identifying implicit recourse than the prior QSPE/VIE accounting (FR 2010; FASB

2009b). However, given the discretion allowed under the new VIE accounting, it is not necessarily more effective at identifying implicit recourse. If the new VIE accounting is more effective at identifying implicit recourse than the prior QSPE/VIE accounting, then investors should have treated as secured borrowings those previously off-balance-sheet securitized assets that were ex-post consolidated as required by the new VIE accounting.

If this is true, then the elimination of QSPE accounting and the replacement of the old

VIE accounting with the new VIE accounting will result in financial reporting that is more aligned with investors’ views of asset securitizations. Thus, an investigation of how

6 I use the term “old VIE accounting” to refer to the quantitative analysis required under FIN 46(R) and use the term “new VIE accounting” to refer to the qualitative analysis required under SFAS 167. 4 investors assessed implicit risk associated with the consolidated assets prior to the adoption of SFAS 166 and SFAS 167 provides insight into the benefits of the analysis required under these two new standards.

Prior research on asset securitizations examines whether investors view securitizations as sales or secured borrowings. These studies predict that if investors anticipate that the securitizing firm will provide implicit recourse to the firm’s underperforming securitizations, then their assessments of the firm’s credit risk should reflect risk associated with securitized assets transferred to SPEs. Consistent with this prediction, the prior studies find that the securitizing firm’s credit risk is positively associated with securitized assets transferred to SPEs. This positive relation indicates that investors assume that, on average, firms will provide implicit recourse on securitized assets, which suggests that investors treat securitizations as secured borrowings on average even when GAAP treats them as sales.

Upon the adoption of the two new standards, some securitized assets were consolidated back onto firms’ balance sheets, but others continued to be accounted for as sales. This raises the question whether, as implied by prior research, investors view all securitizations as secured borrowings or they treat some securitizations as secured borrowings, but others as sales. This question is simple, but very important because firms’ debt-to-assets ratio would dramatically increase if they were to record all of their securitizations as borrowings. With the passage of SFAS 166 and SFAS 167, we can distinguish between securitizations that may have the economic substance of borrowings versus sales.

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The findings from prior studies are limited in that they do not distinguish between securitizations going through two different accounting structures, QSPEs and VIEs, in examining investors’ views on asset securitizations. By meeting conditions required under the prior QSPE/VIE accounting, securitizing firms demonstrated that they had transferred control of the assets to SPEs, but they may have retained significant risk in the assets by providing implicit recourse on the assets. QSPE accounting took into account only the securitizing firm’s explicit obligations, but significantly limited the firm’s involvement with QSPEs to ensure that the firm had relinquished control of the assets.

On the other hand, VIE accounting considered both the firm’s explicit and implicit obligations, but the securitizing firm had more discretion under VIE accounting in making assumptions to estimate its exposure to VIEs (Harp 2005; Niu and Richardson

2006; Moody’s 2010; PCAOB 2011). Given such differences between the two accounting structures, investors may or may not have distinguished between securitizations going through QSPEs and VIEs with respect to implicit recourse in assessing the extent of the risk retained.

Extending prior research, this study examines whether investors distinguished between QSPEs and VIEs prior to the adoption of SFAS 166 and SFAS 167. To identify

QSPE and VIE assets that the securitizing firm would likely provide implicit recourse, I use QSPE and VIE assets that were ex-post consolidated as required by the new standards.

The QSPE assets were consolidated due to both the elimination of QSPE exemption from applying VIE accounting and the replacement of quantitative analysis required under the old VIE accounting with a qualitative analysis. On the other hand, the VIE assets were consolidated only due to the replacement of the quantitative analysis with a qualitative 6 analysis. As such, if QSPE accounting was significantly less effective at identifying implicit recourse than the old VIE accounting, then investors should have assumed that the securitizing firm would be more likely to provide implicit recourse for the consolidated QSPE assets versus the consolidated VIE assets and thus assessed higher implicit risk for the consolidated QSPE assets versus the consolidated VIE assets. Thus, examining whether investors assessed differential implicit risk for the consolidated QSPE assets versus the consolidated VIE assets prior to the adoption of the new standards provides evidence on the relative effectiveness of QSPE accounting to the old VIE accounting at identifying implicit recourse.

Consistent with prior research, my empirical analysis focuses on the relation between the securitizing firm’s equity risk and the level of securitized assets accounted for as sales. Prior research predicts that if equity-holders assess that the securitizing firm bears significant risk in implicit recourse beyond the firm’s contractual obligations, then total securitized assets are positively associated with equity risk beyond the retained interest. While prior research focuses on the pre-crisis periods, the sample period of this study continues into 2012.7 One caveat of this study is that investors may have changed their views on securitizations during the recent financial crisis.8

To distinguish between securitizations that may have the economic substance of borrowings and sales, I hand-collect from banks’ 10-K filings for the fiscal year 2009

QSPE and VIE assets that were either consolidated or unconsolidated upon the adoption

7 To test the equity-holders’ views on asset securitizations before and after the new standards became effective in 2010, the sample period of this study spans 2009 to 2012. 8 Amiram et al. (2011) argue that because of the systematic drop in the value of firms’ assets during the crisis, securitizing firms may not have had the means or willingness to honor their implicit recourse. They document that the positive association between firms’ market value of equity and securitized assets sold to SPEs became insignificant in 2008. 7 of SFAS 166 and SFAS 167. These assets had been treated as sales during fiscal year

2009 under the prior QSPE/VIE accounting. Then, as required by the two new standards, some of the assets were added back onto firms’ balance sheets for the first quarter of

2010 and others continued to be accounted for as sales. I hand-collect the amounts of these assets from firms’ 10-K filings for the fiscal year 2009 that were issued during the first quarter of 2010.

I first test whether investors assessed differential risk in implicit recourse for the consolidated assets versus the unconsolidated assets before the two new standards became effective. Then, I test whether for the consolidated assets investors distinguished between QSPEs and VIEs with respect to implicit recourse prior to the adoption of the new standards. For these tests, I regress equity risk on the level of the assets that was not observable at the time when the equity risk was measured. As such, following prior research, I make an assumption that investors could accurately assess the level of risk associated with securitized assets. Out of 49 banks that had positive securitized assets in at least one quarter between 2008 and 2009, 14 and 7 banks consolidated their QSPE and

VIE assets back onto their balance sheets, respectively.

The findings from this study reveal that equity risk is significantly positively associated with the consolidated assets beyond the unconsolidated assets. This positive relation indicates that investors anticipated that firms would provide implicit recourse for the consolidated assets before the new standards became effective. These findings suggest that investors treated the consolidated assets as borrowings prior to the adoption of the new standards. Regarding the unconsolidated assets, equity risk is not significantly

8 associated with the assets, which provides no evidence that investors treated the unconsolidated assets as borrowings prior to the adoption of the new standards.

Disaggregating the consolidated assets into consolidated QSPE and VIE assets, I find that equity risk is significantly positively associated with both of the assets. These findings suggest that investors treated the consolidated QSPE and VIE assets as borrowings prior to the adoption of the new standards. More importantly, the t-test shows that the coefficients on these assets are not significantly different from each other. These findings indicate that for the consolidated assets, there is no evidence that investors distinguished between QSPEs and VIEs with respect to implicit recourse prior to the adoption of the new standards.

I also test the investors’ assessments of risk associated with securitized assets between 2010 and 2012, that is, after the new standards became effective. I find that equity risk is significantly positively associated with the retained interest in securitized assets, but is not significantly associated with the non-retained interest in the assets.

These findings provide no evidence that investors continue to treat securitizations as borrowings after the new standards became effective.

Overall, the findings from this study imply that i) investors treated consolidated assets as secured borrowings prior to the adoption of SFAS 166 and SFAS 167, ii) for consolidated assets, there is no evidence that investors distinguished between QSPEs and

VIEs with respect to implicit recourse prior to the adoption of the new standards, and iii) after these assets were consolidated, there is no evidence that investors continue to treat securitizations as borrowings. These findings overall suggest that the new accounting standards are more consistent with equity investors’ views of asset securitizations. If 9 investors are correct in assessing the extent of the risk retained, then these findings imply that the new VIE accounting is more effective at identifying implicit recourse than the prior QSPE/VIE accounting.

The findings above suggest that investors distinguished between securitizations that should have been treated under the new standards as borrowings versus sales even before the new standards required firms to do so. A natural follow-up question is how investors could have distinguished between these different types of securitizations given the lack of disclosure about securitizations. One possible information channel that investors could use is the regulatory Y-9C report. A bank’s primary Federal supervisor has the authority to require a bank to add its securitized assets back into its risk-weighted assets for regulatory capital purposes if the agency assesses that the bank has retained significant implicit risk beyond its contractual obligations (FR 2010). Investors may be able to estimate the banking agencies’ implicit recourse adjustments from the regulatory report and use these estimated adjustments to identify those SPEs to which the securitizing firm will likely provide implicit support beyond the firm’s contractual obligations and to estimate the extent of such support.

To test whether investors can estimate and use the banking agencies’ implicit recourse adjustments in assessing the extent of the risk retained, I estimate the amounts of securitized assets added back to banks’ risk-weighted assets from Y-9C reports arising from the adjustments of formerly off-balance-sheet securitized assets. The findings reveal that equity risk is significantly positively associated with the estimated implicit recourse adjustments. These findings suggest that investors are able to estimate and use the banking agencies’ implicit recourse adjustments in assessing the extent of the implicit 10 risk retained. Put differently, investors’ views about implicit recourse are consistent with the banking agencies’ implicit recourse adjustments.

This study contributes to the literature relating the risk relevance of asset securitizations along several dimensions. First, I provide evidence that SFAS 166 and

SFAS 167 result in financial reporting that is more aligned with investors’ views of asset securitizations. Assuming that investors are correct in assessing the extent of the risk retained, these findings imply that the new accounting standards better reflect the economics of securitization transactions, which is consistent with the FASB’s main objective for adopting the standards (FASB 2009a; FASB 2009b). However, readers should be cautious in interpreting the findings because this implication is predicated on the assumption that, on average, investors can accurately assess the level of risk in securitized assets. As suggested in Cheng et al. (2011), some investors may have difficulty in understanding securitization disclosures and as a result, may not be accurate in their assessments. To the extent that this is true, the findings should not be interpreted as suggesting the relative effectiveness of the new accounting standards to the old accounting standards at identifying implicit recourse. The findings should be interpreted as suggesting only that investors’ views about implicit recourse are more consistent with the new accounting standards than the old accounting standards.

The findings from this study imply that investors were able to distinguish between securitizations that were ex-post consolidated and unconsolidated even before the new standards required firms to make the distinction. If on average investors could draw the distinction without such new disclosure, then the natural question is who, if any, will benefit from the new accounting standards. The new disclosure may be useful for 11 auditors. The Public Company Accounting Oversight Board (PCAOB) conducted inspections of audit procedures by registered public accounting firms and released a report on its observations related to audit risk areas affected by the recent financial crisis

(PCAOB 2010). According to the report, inspectors observed that firms sometimes failed to re-evaluate the accounting for securitizations even when the implicit recourse on securitized assets became explicit. Firms may have failed to incorporate the risk associated with implicit recourse because either they ignore implicit risk or the old accounting standards did not push them strongly enough to incorporate the risk. If the latter is true, then the new accounting standards may be helpful in making auditors take into account the risk associated with implicit recourse.

Next, no current study has offered a mechanism by which investors could estimate the amount of risk retained in off-balance-sheet items. By providing evidence on the information used by investors, this study sheds light on the mechanism and thereby, presents findings that are potentially useful to standard setters.

The remainder of the paper proceeds as follows. Section 2 provides background information about asset securitizations. Section 3 reviews related research and Section 4 discusses my hypotheses. Section 5 describes the research methodology. Section 6 describes the sample selection process and descriptive statistics. Section 7 presents the empirical analyses and Section 8 discusses robustness tests. Section 9 concludes.

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Chapter 2. Background on Asset Securitizations

2.1 Typical Structure of Asset Securitizations

In a typical securitization, a firm transfers pools of financial assets such as mortgages and credit card receivables into an SPE. In return, the SPE conveys the cash it receives from outside investors back to the securitizing firm. Because the securitizing firm knows more about the credit risk of the transferred assets, the firm usually provides some form of recourse to the SPE investors to protect them against potential future losses from these assets. In the context of securitization transactions, recourse usually refers to guaranties promised to investors in asset-backed securities allowing the transfer of some losses back to the originating firm if the performance of the underlying pools of securitized assets deteriorates (Cheng et al. 2011). Therefore, the extent to which the securitizing firm retains risk associated with securitizations varies depending on how much recourse, if any, the firm will provide to its underperforming securitizations.

Recourse can take either an explicit (i.e., contractual) or implicit (i.e., non- contractual) form. For example, as an explicit form of recourse, the securitizing firm typically retains the most subordinated asset-backed securities that bear the first loss from the pool of securitized assets. Because explicit guarantees to the SPE violate accounting rules allowing sale accounting, the securitizing firm may instead offer an implicit promise to support its troubled securitizations to make up some portion of the losses not covered by the retained interest. Even though the securitizing firm is not legally obligated

13 to honor its implicit recourse, the firm may choose to do so to maintain its reputation and future access to securitization markets (Gorton and Souleles 2005). Loss of reputation can expose firms to decreased liquidity, increased interest rate risk, and potential burdensome regulatory supervision (Cheng et al. 2011).

The possible presence of implicit recourse offered by the securitizing firm makes it difficult for investors to assess the extent of the risk retained. This is because implicit recourse was neither disclosed nor recognized in the financial statements under SFAS

140. Thus, it is difficult for investors to identify such implicit commitments. Further, the securitizing firm may or may not honor its implicit commitments at its discretion.9

Therefore, to assess the extent of the risk retained, investors should estimate the likelihood and extent of the securitizing firm providing implicit recourse.

2.2 Accounting for Asset Securitizations

Prior to 2010, firms were able to keep securitized assets off their balance sheets using either QSPE or VIE accounting. QSPE and VIE accounting were allowed under

SFAS 140 and FIN 46(R), respectively. After the beginning of 2010, all securitizations should be evaluated for off-balance-sheet treatment in accordance to SFAS 166 and

SFAS 167. SFAS 166, among other things, eliminates the QSPE exemption from applying VIE accounting and SFAS 167 replaces the quantitative analysis required under

VIE accounting with a qualitative analysis.

2.2.1 SFAS 140 and FIN 46(R)

9 In April 30, 2009, Advanta Corp. announced at its earnings call that it would support its credit card securitizations to prevent early amortization. However, In May 11, 2009, Advanta Corp. announced that it will shut down all of the accounts in the securitization trusts without supporting them. 14

Prior to 2010, to obtain off-balance-sheet treatment for assets transferred to an

SPE, the securitizing firm was required to demonstrate that the transfer of the assets met the conditions required under SFAS 140 to be treated as a sale, and that the firm did not have a controlling financial interest in the SPE in accordance to FIN 46(R). However,

QSPE accounting allowed under SFAS 140 provided a means to demonstrate that the securitizing firm had relinquished control of the transferred assets. Therefore, if an SPE was considered a QSPE, then the SPE was exempt from consolidation requirements required under FIN 46(R). As such, each securitization involving QSPEs needed to meet only the conditions required under SFAS 140.

Under SFAS 140, securitization transactions could be accounted for as sales rather than as secured borrowings if the transfer of all or a portion of a financial asset met all of the three conditions: (1) the transferred assets must be isolated from the transferor and its creditors even in bankruptcy, (2) the SPE (or each holder of its beneficial interests if the SPE is a QSPE) must have the right to pledge or exchange the assets (or beneficial interests) it receives, (3) the securitizing firm does not maintain effective control over the transferred assets through certain forms of continuing involvement (e.g., the obligation to repurchase the transferred assets). If a securitization transaction was considered a sale, then the securitizing firm removed the securitized assets from its balance sheet, and recognized the proceeds received from the SPE and the firm’s retained interest in the assets. The securitizing firm’s implicit recourse was not considered.10

10 To determine the gain or loss on sale of the assets, the firm allocated the carrying amount of the securitized assets to the retained and non-retained interest based on their relative fair values. 15

To be considered a QSPE, an SPE should have been significantly limited in certain aspects. For example, the assets the SPE could hold and the activities the SPE could perform should have been significantly limited and entirely pre-specified in the legal documents. The SPE could also dispose of its assets only in automatic response to pre-specified events (e.g., a default by the obligor). These conditions required under

QSPE accounting ensured that none of the parties involved in securitization transactions actively managed the transferred assets, and therefore, meeting the conditions demonstrated that the securitizing firm had relinquished control of the assets. Thus, for those securitizations that qualified for off-balance-sheet treatment under QSPE accounting, the securitizing firm may not have had the incentive and/or opportunity to provide support beyond the firm’s contractual obligations and thus, may have borne minimal risk associated with implicit recourse. However, the conditions required under

QSPE accounting took into account only the firm’s contractual obligations and the firm’s non-contractual obligations such as implicit recourse were not considered. As such,

QSPE accounting may not have been effective at identifying securitizations to which the securitizing firm would likely provide implicit recourse.

The conditions for the consolidation of VIEs under FIN 46(R) emphasized the quantitative-based risks and rewards calculation for determining which of the entities had a controlling financial interest in a VIE. An SPE was considered a VIE if the SPE was insufficiently capitalized or was not controlled through voting (or similar rights). If an

SPE was considered a VIE, then a variable interest holder had to consolidate assets and liabilities held in the VIE if it was a primary beneficiary of the VIE. A firm was considered a primary beneficiary if it absorbed a majority of the VIE's expected losses, 16 received a majority of the VIE’s expected residual returns, or both. Therefore, the primary beneficiary was exposed to the greatest risks and/or rewards associated with assets and liabilities held in the VIE, which justified the consolidation of the VIE by the securitizing firm considered the primary beneficiary.

In contrast to QSPE accounting, VIE accounting explicitly required the securitizing firm to consider its implicit recourse as well as explicit recourse in estimating its exposure to potential losses from assets transferred to VIEs (FASB 2003; FSP 2005).

As such, VIE accounting may have been more effective at identifying implicit recourse than QSPE accounting. However, the securitizing firm had more discretion under VIE accounting in making assumptions to estimate its exposure to VIEs (FASB 2009b). Thus, it is possible that the securitizing firm might not have incorporated any of its implicit recourse. Therefore, VIE accounting may not have been more effective at identifying implicit recourse.

2.2.2 SFAS 166 and SFAS 167

As observed during the recent financial crisis, some securitizing banks actually provided implicit recourse to their off-balance-sheet securitizations. Regulators and the

FASB expressed serious concerns about QSPE accounting that had been misused by some firms. The FASB was also concerned that the quantitative analysis required under

VIE accounting did not always capture situations in which securitizing firms provided implicit recourse to their VIEs (FASB 2009b).11 In response, the FASB issued two exposure drafts to amend SFAS 140 and FIN 46(R) in September 2008. These two drafts

11 For example, some sponsors sold their interests to third parties that absorbed the majority of the VIEs’ expected losses. However, these parties typically had very limited power to direct the activities (FASB 2009b). 17 propose to eliminate the QSPE exemption from applying VIE accounting and to make changes to the analysis required under VIE accounting. Along with the drafts, in

December 2008, the FASB also issued FSP FAS 140-4 and FIN 46(R)-8, which require firms to provide additional disclosures about their continuing involvement with SPEs.

The two exposure drafts led to two new standards issued in June 2009, SFAS 166 and

SFAS 167, which became effective at the first annual reporting period that begins after

November 15, 2009.12 For firms with a calendar year end, the new standards became effective from January 1, 2010.

SFAS 166, among other things, removes the QSPE exemption from applying VIE accounting and requires retained interest to be measured at fair value. Changes to SFAS

140 other than the removal of the QSPE exemption must be applied to transfers occurring on or after the effective date, and all QSPEs in existence upon the adoption of the statement had to be evaluated for the consolidation of VIEs in accordance to SFAS 167.

This new statement replaces the quantitative tests with qualitative tests to determine whether a securitizing firm is a primary beneficiary of the VIE. As such, all VIEs in existence upon the adoption of SFAS 167 also had to be evaluated for the consolidation of VIEs in accordance to this new statement.

As a result of the adoption of SFAS 166 and SFAS 167, some QSPE and VIE assets were consolidated back onto firms’ balance sheets. These assets had been treated as sales during the fiscal year 2009 under the prior QSPE/VIE accounting. Then, as required by the two new standards, the assets were added back onto firms’ balance sheets for the first quarter of 2010. I hand-collect the amounts of these consolidated assets from

12 Please see Appendix A for the timeline of accounting standards for asset securitizations. 18 firms’ 10-K filings for the fiscal year 2009 that were issued during the first quarter of

2010.

Under SFAS 167, a variable interest holder is considered a primary beneficiary if it has the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and has the obligation to absorb losses of the entity or the right to receive benefits from the entity that could potentially be significant to the VIE. Under the new VIE accounting, the FASB expects only one party to be the primary beneficiary.

However, if power is shared among multiple unrelated parties, then no party is the primary beneficiary.13

Such a qualitative approach may more readily identify implicit arrangements because it analyzes the characteristics of variable interests and VIEs, including their purpose and design, which could help identify which of the entity has the incentive and opportunity to establish implicit arrangements (FASB 2009b). The FASB expects that the qualitative approach is more effective at identifying implicit recourse than the quantitative approach (FASB 2009b).14 However, the qualitative approach may require firms to make even more subjective judgments and assumptions in determining the primary beneficiary. As such, the qualitative approach may not be more effective at identifying implicit recourse.

13 Power is shared if two or more unrelated parties have the power to direct the activities and if decisions about those activities require the consent of each of the parties (paragraph 14D, FASB 2009b). 14 The banking agencies also note that such qualitative analysis converges in many respects with their assessments of banks’ credit risk exposure to VIEs (FR 2010). 19

Chapter 3. Related Literature Review

Accounting for asset securitizations has been controversial for decades. Even though many securitization transactions were treated as sales under GAAP, various groups argued that these transactions should be considered borrowings. This is because firms may retain significant risk in the transferred assets by providing implicit recourse on securitized assets. To provide insight into the ongoing controversy surrounding the financial reporting for assets securitizations, prior research examines investors’ views about implicit recourse. One caveat for addressing this question is that implicit recourse was neither recognized nor disclosed under GAAP and if any, there are only a handful of events when firms announced that they had committed to provide implicit recourse to their underperforming securitizations. Because the risk associated with the transferred assets should capture the risk associated with implicit recourse, prior research examines whether investors assess significant risk in the transferred assets to test investors’ views about implicit recourse. To draw a policy implication, prior research has relied on the assumption that investors can accurately estimate the risk associated with implicit recourse. Following this line of research, this study also assumes that investors can accurately assess the level of risk in securitizations to test investors’ views about implicit recourse.

To examine investors’ views about implicit recourse, prior research focuses on the investors’ assessments of the relation between the securitizing firm’s risk and securitized

20 assets. These studies predict that if investors anticipate that the securitizing firm will (will not) provide implicit recourse beyond the firm’s contractual obligations to its troubled securitizations, then the measure of the firm’s risk should (not) be positively associated with the portion of assets transferred to SPEs. Niu and Richardson (2006) show that off- balance-sheet debt related to asset securitizations has the same risk relevance as does recognized debt for explaining market measures of equity risk (i.e., CAPM beta).

Landsman et al. (2008) show that SPE assets and liabilities are valued similarly to sponsor-originator banks (S-Os) assets and liabilities. These findings indicate that equity- holders assume that on average firms will provide implicit recourse on securitized assets, suggesting that investors view securitizations as secured borrowings even when GAAP treats them as sales. Assuming that investors can accurately assess the risk in securitizations, these studies argue that their results raise questions about whether the sales accounting treatment for asset securitizations appropriately reflects the risk associated with implicit recourse.

Chen et al. (2008) investigate whether the equity-holders’ assessments of risk associated with securitizations vary with the type of assets securitized. They show that equity return volatility is positively associated with both retained and non-retained interest in securitized residential mortgages and securitized consumer loans, but is positively associated only with the retained interest in securitized commercial loans.

These findings suggest that equity-holders perceive that implicit recourse is a more important issue for residential mortgages and consumer loans than for commercial loans.

Cheng et al. (2011) investigate the sources of equity risk associated with securitizations. They argue that market participants are likely to find it difficult to assess 21 the true extent of risk transfer because of the complexity of and the lack of disclosure about securitization transactions. They predict that the difficulty in estimating the extent of risk transfer is likely to lead to information asymmetry among market participants if some market participants have better information and/or better information-processing abilities. Consistent with their predictions, they find that bid-ask spreads and analyst forecast dispersion increase with the amount of securitized assets, and that securitizing banks have higher bid-ask spreads and forecast dispersion as compared to non- securitizing banks. These findings imply that some investors have a greater difficulty in understanding securitization disclosures. This implication suggests that better disclosure about implicit recourse should be incorporated to level the playing field.

To test investors’ views about implicit recourse, following prior research, this study makes an assumption that investors can accurately assess the risk in securitizations.

The extent that this assumption is valid is not trivial because different conclusions may be drawn. Niu and Richardson (2006) and Landsman et al. (2008) argue that investors do not rely on the sales accounting treatment because the accounting is not appropriate. On the other hand, Cheng et al. (2011) suggest that investors may not rely on the sales accounting treatment because they have difficulty in estimating the extent of risk transfer.

Beatty and Liao (2013) suggest that further research in this area may help reconcile the potential inconsistency. The objective of this study is not to test the validity of this assumption. Following prior research, this study assumes the market efficiency to test investors’ views about implicit recourse and then to make an implication on the relative effectiveness of the new VIE accounting to the prior QSPE/VIE accounting at identifying implicit recourse. 22

Barth et al. (2012) investigate whether two credit market participants, bondholders and Standard & Poor’s (S&P’s), differ in their assessments of credit risk associated with securitized assets. They find that bond spreads are positively associated with both retained and non-retained interest in securitized assets regardless of the type of assets securitized, whereas S&P’s credit ratings are positively associated only with the retained interest in securitized residential mortgages. They claim that if the bond market’s assessment of the securitizing firm’s off-balance-sheet exposure is unbiased and efficient, then their findings raise questions about the appropriateness of reporting the non-retained interest as sold to SPEs as well as the diligence of credit-rating agencies in assessing credit risk associated with securitizations.15

Overall, prior research on asset securitizations indicates that investors assume that on average securitizing firms will provide implicit recourse to their underperforming securitizations, suggesting that investors treat securitizations as secured borrowings on average. Upon the adoption of SFAS 166 and SFAS 167, some securitized assets were consolidated back onto firms’ balance sheets. This raises the question whether, as implied by prior research, investors treat all securitizations as borrowings or they treat some securitizations as borrowings, but others as sales. The findings from prior studies are also limited in that they do not distinguish between securitizations going through two different

15 Another stream of research investigates motivations for asset securitizations. Two of the motivations that have been examined in prior studies are to meet the bank’s regulatory capital requirements and to manage earnings. Empirical findings for the regulatory arbitrage motivation are mixed (Minton et al. 2004; Karaoglu 2005). Regarding the earnings management motivation, Dechow and Shakespeare (2009) find that securitization transactions cluster in the last few days of the third month of the quarter, suggesting that managers use securitizations to window-dress the financial statements. Dechow et al. (2010) find that firms report larger gains when pre-securitization earnings are lower and when pre-securitization earnings are below the last year’s level. 23 accounting structures, QSPEs and VIEs, in examining investors’ views on asset securitizations.

Upon the adoption of SFAS 166 and SFAS 167, some QSPE and VIE assets were consolidated back onto firms’ balance sheets because firms were deemed to have control over the assets under the two new standards. As such, for those consolidated assets, firms may have the incentive and/or opportunity to provide implicit recourse. However, having control over the assets does not guarantee that firms will provide implicit recourse. Firms may not have the incentive to provide implicit recourse because they assess that the benefit of waiving the recourse is greater than the cost of losing reputation as a player in the securitization market. Thus, whether the new standards capture the risk associated implicit recourse that the prior standards missed is an empirical question. Because implicit recourse is rarely observable, I address the question by examining how investors assessed implicit risk associated with the consolidated assets versus the unconsolidated assets before the new standards became effective. This study also extends prior research by examining whether for the consolidated assets investors assessed differential risk in implicit recourse for assets securitized through QSPEs versus VIEs prior to the adoption of the new standards.

24

Chapter 4. Hypotheses Development

To test whether investors view all securitizations as borrowings, I use securitized assets that were (were not) consolidated as required by SFAS 166 and SFAS 167 to identify securitizations that the securitizing firm will (will not) likely provide implicit recourse. These two new standards eliminate the QSPE exemption from applying VIE accounting and replace the quantitative analysis required under VIE accounting with a qualitative analysis. As such, if the qualitative analysis is more effective at identifying implicit recourse than QSPE accounting and the quantitative analysis, then investors should have treated, prior to the adoption of the new standards, as secured borrowings those securitized assets that were ex-post consolidated under the qualitative analysis, but others as sales. If this is true, then investors should have assessed significantly higher risk for the consolidated assets versus the unconsolidated assets. Thus, my first hypothesis is as follows.

H1: The magnitude of the association between the securitizing firm’s equity risk and securitized assets that were consolidated as required by SFAS 166 and SFAS 167 is significantly greater than that of the association between the firm’s equity risk and securitized assets that were unconsolidated.

To test whether investors distinguished between QSPEs and VIEs with respect to implicit recourse, I use QSPE and VIE assets that were consolidated as required by the two new standards to identify QSPE and VIE assets that the securitizing firm would

25 likely provide implicit recourse. The QSPE assets were consolidated due to both the elimination of QSPE exemption from applying VIE accounting and the replacement of quantitative analysis required under the old VIE accounting with a qualitative analysis.

On the other hand, the VIE assets were consolidated only due to the replacement of the quantitative analysis with a qualitative analysis. As such, if QSPE accounting was significantly less effective at identifying implicit recourse than VIE accounting, then investors should have assumed that the securitizing firm would be more likely to provide implicit recourse for the consolidated QSPE assets versus the consolidated VIE assets and thus assessed higher implicit risk for the consolidated QSPE assets versus the consolidated VIE assets. Below is my second hypothesis.

H2: The magnitude of the association between the securitizing firm’s equity risk and securitized assets transferred to QSPEs that were consolidated as required by SFAS 166 and SFAS 167 is significantly greater than that of the association between the firm’s equity risk and securitized assets transferred to VIEs that were consolidated.

Prior research shows that investors do not assess differential risk for the retained interest in securitized assets versus the non-retained interest in the assets. If those securitized assets treated by investors as secured borrowings were consolidated as required by the two new standards, then one would expect that they treat as sales those securitized assets that remain off-balance-sheet after the new standards became effective.

In this case, investors should assess significantly higher risk for the retained interest versus the non-retained interest after the new standards became effective. My third hypothesis is as follows.

26

H3: After SFAS 166 and SFAS 167 became effective, the magnitude of the association between the securitizing firm’s equity risk and the retained interest in securitized assets is significantly greater than that of the association between the firm’s equity risk and the non-retained interest in the assets.

This study suggests and tests one possible information channel provided by the banking agencies that investors might use to identify securitizations to which the securitizing firm will likely provide implicit recourse and to estimate the extent of the recourse. If a securitizing bank has provided implicit recourse to its securitizations, then the bank is required to add the securitized assets back to its risk-weighted assets. It is possible that investors can estimate the increase in banks’ risk-weighted assets arising from the adjustments of formerly off-balance sheet securitized assets from banks’ regulatory reports and use these estimated amounts in assessing the extent of the implicit recourse provided. Thus, my fourth hypothesis is as follows.

H4: The securitizing firm’s equity risk is positively associated with the increase in banks’ risk-weighted assets arising from the adjustments of formerly off-balance- sheet securitized assets.

27

Chapter 5. Research Design

Following prior research on asset securitizations, this study focuses on asset securitizations of bank holding companies because financial institutions make up the largest portion of total securitization volume (Dechow et al. 2010). To test whether investors treat securitizations as sales or secured borrowings, this study also focuses on securitization transactions for which sponsors apply sale treatment. These transactions are not recognized in the statement of financial position, but securitization information can be obtained from the Y-9C reports that all bank holding companies with consolidated assets in excess of $500 million must file with the Federal Reserve.

As a baseline model, this study uses the model from Chen et al. (2008) as below and then extends the model to test my hypotheses. Following their research design, this study uses the standard deviation of daily stock returns to test the equity-holders’ assessments of the securitizing firm’s off-balance-sheet exposure.16 To test whether equity-holders treat securitizations as secured borrowings, Chen et al. (2008) estimate the relation between equity risk and total securitized assets beyond the retained interest and control variables as follows:

σRit+1 = α0 + α1Securitizedit + α2Retainedit + α3EarnVolit + α4LiquidAssetsit + α5Securitiesit + α6Sizeit + α7ChargeOffsit + α8PastDueit + α9IntDerivit + α10TRADINCit + α11SECINCit + α12T1_RISKit + α13GAPit + α14Loansit + α15AssetGrowthit + ɛit+1 (Baseline)

16 Requiring my sample banks to have either a bond spread or credit ratings significantly reduces the already small sample size. As such, it is not feasible to test how debt-holders and credit rating agencies view asset securitizations using my sample. 28

σRit+1 is the standard deviation of daily stock returns for the quarter following the measurement of the securitized assets.17 Securitized is total securitized assets, which are the sum of the retained and non-retained interest, scaled by market value of equity.

Retained is retained interest scaled by market value of equity.

Regarding control variables, EarnVol is the standard deviation of earnings per share for the past six quarters; LiquidAssets is the sum of cash, available-for-sale securities, trading assets, federal funds sold, and securities purchased with intent to resell;

Securities is the sum of available-for-sale and held-to-maturity securities minus retained interest, scaled by total assets; Size is the natural logarithm of total assets; ChargeOffs is net loan charge-offs; PastDue is total loans 30 or more days past due; IntDeriv is the notional amount of interest rate derivatives; TRADINC is trading income during quarter;

SECINC is the sum of servicing fee and securitization income during quarter; T1_RISK is

Tier 1 risk-based capital ratio; GAP is the absolute value of difference between book values of assets and liabilities expected to reprice in the following year; Loans is total loans outstanding; AssetGrowth is the percentage growth in managed asset (assets plus total securitized loans); all continuous variables but EarnVol, Securities, and T1_RISK are scaled by market value of equity.

To control for differences in the risk of banks’ various types of on-balance sheet loans, Chen et al. (2008) disaggregate total loans (Loans) into three categories: mortgage loans, consumer loans, and commercial loans. However, I choose to not break total loans

17 Following Chen et al. (2008), this study uses banks’ total equity risk as measured by stock return volatility to measure banks’ credit risk. Prior studies show that banks’ credit risk has both unsystematic and systematic components with the unsystematic component dominating and that banks’ return volatility is positively associated with measures of their credit risk (Hall et al. 2001; Zhang 2013). 29 into the three categories in my primary regression analyses for the following reason. A majority of my sample firms report my main test variable—the amounts of consolidated securitized assets—in aggregate amounts without breaking it into the three categories.

Only five out of 17 banks with positive consolidated assets report the amounts of the assets by each type. Because of the small sample with disaggregated amounts of consolidated assets, it is not feasible to estimate the relation between equity risk and each type of consolidated asset and thus, I do not break the assets into the three categories.

To address my main research question, I compare the risk in securitized assets consolidated under the new standards to the risk in securitized assets unconsolidated.

Because aggregate amounts of the consolidated assets do not capture risk differences across the three types of assets, but averages the risk in the assets, the relative risk of each type of consolidated assets to the same type of unconsolidated assets may not be correctly captured when only the unconsolidated assets are broken into the three types. For example, if a majority of the consolidated assets are mortgage loans, which are typically less risky than consumer and commercial loans, then the consolidated assets can appear to be as risky as or less risky than the unconsolidated consumer and commercial loans even when the consolidated mortgages are riskier than the unconsolidated mortgages. As a result, the consolidated assets may appear to have an insignificant or negative relation with equity risk beyond the unconsolidated assets when the consolidated assets actually have a positive relation. Because it is not clear whether the aggregate amounts of consolidated assets correctly capture risk in the assets after controlling for risk differences across the three types of loans, I do not break total securitized assets and

30 loans into the three types in my primary regression analyses. However, as a robustness check, I estimate the model using the three types of loans.

I use a five percent significance level under a two-sided alternative to evaluate whether particular coefficients differ from zero. I use a one-sided alternative when evaluating whether a coefficient is greater than another. Standard errors are computed with firm-level clustering to adjust for the correlation of residuals across time. Quarter and/or year indicators are also included to control for any quarter and/or year fixed effects.

To test investors’ assessments of the securitizing firm’s off-balance-sheet exposure, prior research focuses on the signs and significance of the coefficients on

Securitized and Retained, α1 and α2. Because Securitized is the sum of non-retained interest and retained interest in securitized assets, the coefficient on Retained offsets the coefficient on Securitized and therefore, captures the risk associated with the retained interest beyond the risk associated with the non-retained interest, captured in α1. As such, if investors assess significantly higher risk for the retained interest versus the non- retained interest, then α2 should be significantly positive. Equivalently, such incremental risk associated with the retained interest can also be tested by disaggregating total securitized assets into the retained and non-retained interest and testing whether the coefficients on the interest are significantly different from each other. To make my research design consistent with prior research, I use the baseline model that includes the retained interest offsetting total securitized assets.

If investors assess that the securitizing firm’s credit risk is associated with both retained and non-retained interest in the securitized assets, then α1 should be positive. 31

This could be the case if investors view that the securitizing firm’s credit risk exposure stems from both the firm’s contractual retained interest and non-contractual obligations

(i.e., implicit recourse). If investors perceive both retained and non-retained interest as equally relevant in assessing the securitizing firm’s credit risk, then α1 should be positive and α2 should be zero. In contrast, if investors assess that the securitizing firm’s credit risk is associated only with the firm’s contractual retained interest, then α2 should be positive and α1 should be zero. This could be the case if investors view the risk posed to sponsors of securitization by implicit recourse to be immaterial and the firm’s credit risk exposure is limited to their contractual retained interest.

In short, the coefficient on Securitized can be positive if investors assess that firms retain significant risk associated with implicit recourse. The risk associated with implicit recourse is largely determined by two factors, i) the anticipated need for future support for troubled securitizations (i.e., expected future losses associated with securitized assets) and ii) banks’ willingness and potential methods of offering support, if the need arises (Cheng et al. 2011). As such, the coefficient on Securitized can be positive if both of the two factors are positive. Therefore, the positive coefficient on Securitized reflects that investors anticipate that firms will provide implicit recourse to their underperforming securitizations.

Regarding the control variables, I expect firms that are smaller and have greater earnings volatility and asset growth have higher equity risk (Beaver et al. 1970; Hall et al.

2001). I also expect that liquid assets are associated with less equity risk, but have no expectation on the liquidity of securities relative to other liquid assets (Barth et al. 2012).

Because undercapitalized firms are less likely to provide protection against unexpected 32 losses, I expect firms with a lower Tier 1 risk-based capital ratio to have higher equity risk. Loans could be positively or negatively correlated with the equity risk depending on various factors such as the extent of banks hedging the risks of the loans and banks’ choices to hold or securitize loans. Charge-offs and past due loans are expected to be associated with higher equity risk. Because interest rate derivatives can be used to either increase or decrease risk, I have no expectation on the signs of the derivatives. Interest rate risk results from mismatching of the repricing characteristics of assets and liabilities and therefore, I expect the gap between the values of assets and liabilities to be positively associated with higher equity risk. Because risks associated with trading income and securitization income depend on many different factors including banks’ risk management, trading positions, and/or dependence on these incomes, I have no expectation on the trading and securitization income (Chen et al. 2008).

5.1 Tests of H1 - H3

To test whether investors assessed significantly higher risk in implicit recourse for the consolidated assets versus the unconsolidated assets before SFAS 166 and SFAS 167 became effective (H1), I estimate the relation between σR and consolidated securitized assets (CONS_Securitized) beyond Securitized during 2009 as follows.18

σRit+1 = β 0 + β1CONS_Securitizedit + β2Securitizedit + β3Retainedit + βControls + ηit+1 (1)

CONS_Securitized is the sum of QSPE and VIE assets that were consolidated as required by the two new standards. I collect consolidated QSPE assets (CONS_QSPE) and consolidated VIE assets (CONS_VIE) from banks’ 10-K filings for the fiscal year 2009

18 Control variables (Controls) used in Equation (1) through Equation (4) are the same as those used in the Baseline. 33 applying the following procedures.19 When banks disclose the amounts of QSPE and VIE assets consolidated, then I record these amounts. When banks disclose both the amounts of securitized assets consolidated and the type of the assets without distinguishing between QSPEs and VIEs, I match that type to the type of assets securitized through

QSPEs and VIEs by reading parts of the filings related to securitizations. When banks disclose only the amounts of VIE assets consolidated, I also look for the type of assets securitized through QSPEs and VIEs to ensure that the consolidated VIE assets are not the QSPE assets. Because QSPEs were determined to be considered VIEs under SFAS

167, some banks use VIEs to refer to QSPEs. When there is no sufficient information to determine whether an SPE is a QSPE or a VIE, I record zero QSPE and VIE assets.

When banks mention that the impact of adoption of the new standards is immaterial, I set

CONS_QSPE and CONS_VIE to zero. Then, CONS_QSPE and CONS_VIE are used for the four quarters of 2009.20

To test H1, this study focuses on the sign and significance of the coefficient on

CONS_Securitized, β1. Because Securitized comprises securitized assets that were either consolidated or unconsolidated upon the adoption of the new standards, the coefficient on consolidated securitized assets (CONS_Securitized) offsets the coefficient on Securitized.

As such, the coefficient on Securitized reflects the investors’ assessments of risk associated with the unconsolidated assets. Therefore, β1 reflects the investors’ assessments of risk associated with the consolidated assets beyond the risk associated

19 Please see Appendix B for three examples that banks disclose the impact of SFAS 166 and SFAS 167 on their assets. 20 I assume that the same amounts of securitized assets as CONS_QSPE and CONS_VIE were held in QSPEs and VIEs, respectively during 2009. This assumption is reasonable in that the maturity of mortgage backed securities for many banks is longer than five or ten years. 34 with the unconsolidated assets, captured in β2. Equivalently, rather than including the consolidated assets offsetting total securitized assets, the incremental risk associated with the consolidated assets can also be tested by disaggregating total securitized assets into consolidated and unconsolidated assets and then testing whether the coefficients on these assets are significantly different from each other. Because I use the offsetting model as my baseline model, to maintain consistency, I include the consolidated assets offsetting total securitized assets as in Equation (1). Retained comprises the retained interest in securitized assets that were either consolidated or unconsolidated. Because explicit obligations that expose the securitizing firm to a significantly high risk violate sale accounting, this study assumes that there is no significant difference between consolidated and unconsolidated securitized assets in terms of the level of risk associated with the retained interest. Thus, β3 reflects the investors’ assessments of risk associated with the retained interest beyond the unconsolidated assets. Following H1, I predict that

β1 is significantly positive.

Next, to test whether for the consolidated assets investors assessed differential risk for assets securitized through QSPEs versus VIEs prior to the adoption of SFAS 166 and SFAS 167 (H2), I extend Equation (1) by disaggregating consolidated securitized assets (CONS_Securitized) into consolidated QSPE assets (CONS_QSPE) and consolidated VIE assets (CONS_VIE) as follows.

σRit+1 = γ0 + γ1CONS_QSPEit + γ2CONS_VIEit + γ3UNCONS_QSPEit + γ4Securitizedit + γ5Retainedit + γControls + μit+1 (2)

I also include unconsolidated QSPE assets (UNCONS_QSPE) to provide a fuller picture of investors’ views on securitized assets that were not consolidated upon the adoption of

35 the two new standards. UNCONS_QSPE is computed as total QSPE assets minus the consolidated QSPE assets (CONS_QSPE).

Similar to Equation (1), Securitized comprises QSPE and VIE assets that were either consolidated or unconsolidated upon the adoption of the new standards, and all but unconsolidated VIE assets are included in Equation (2). As such, the coefficient on

Securitized reflects the investors’ assessments of risk associated with the unconsolidated

VIE assets. Therefore, γ1, γ2, and γ3 reflect the investors’ assessments of risk associated with the consolidated QSPE assets, consolidated VIE assets, and unconsolidated QSPE assets, respectively, beyond the risk associated with the unconsolidated VIE assets, captured in γ4. Retained comprises the retained interest in the securitized assets held in

QSPEs and VIEs. Because explicit obligations that expose the securitizing firm to a significantly high risk violate sale accounting, this study assumes that there is no significant difference between QSPEs and VIEs in terms of the level of risk associated with the retained interest. Thus, γ5 reflects the investors’ assessments of risk associated with the retained interest beyond the unconsolidated VIE assets.

To test H2, this study focuses on the magnitude of the difference between the coefficients on CONS_QSPE and CONS_VIE. H2 predicts that if investors assessed significantly higher implicit risk for the consolidated QSPE assets versus the consolidated

VIE assets prior to the adoption of the new standards, then γ1 should be significantly greater than γ2. Equivalently, this differential risk associated with the consolidated QSPE assets versus the consolidated VIE assets can also be tested by including total consolidated assets (CONS_Securitized) that are offset by the consolidated QSPE assets and then testing whether the coefficient on the consolidated QSPE assets is different from 36 zero. This offsetting model is more consistent with the Baseline and Equation (1).

However, as in Equation (2), I choose to break total consolidated assets into the consolidated QSPE and VIE assets to separately test the investors’ assessments of the risk associated with these assets. For other models used in this study, I use the offsetting model to maintain consistency.

The difference between the coefficients on securitized assets from Equation (2)

(e.g., CONS_QSPE versus CONS_VIE) can be significant if investors anticipate that firms will provide implicit recourse only for one of the assets. However, the difference can also be significant if expected losses from one of the assets are significantly different from expected losses from the other. Unfortunately, my regulatory and other available data sources do not distinguish between the two factors (i.e., expected losses from securitized assets and banks’ willingness of offering implicit recourse for the assets). This is a limitation of my study and of the previous studies that suffered from the same issue.

However, I believe this limitation is relatively mild because it is likely that the two factors are positively correlated. Firms are more likely to provide implicit recourse for those securitized assets that are expected to have greater future losses. Prior research on asset securitizations finds the positive coefficient on Securitized, which suggests a possibility that those two factors are positively correlated. If this is true, then the significance of the difference between banks’ willingness of offering implicit recourse for two types of securitized assets is likely to be highly correlated with that of the difference between expected losses from these assets. Therefore, to the extent that those two factors are positively correlated, the significant difference between the coefficients on the assets

37 reflects that investors anticipate that firms will be more likely to provide implicit recourse for one of the assets.

Next, to test whether investors treat securitizations as sales after the new standards became effective in 2010 (H3), I estimate the relation between equity risk and total securitized assets beyond the retained interest as in the Baseline model between

2010 and 2012. H3 predicts that if those securitized assets treated by investors as secured borrowings were consolidated as required by the two new standards, then α2 should be positive after the new standards became effective.

5.2 Tests of H4

Next, this study examines how investors distinguish between securitizations that are borrowings versus sales. Y-9C reports from the Federal Reserve represent one of the few sources of detailed data regarding securitizations. This study tests whether investors use the amounts of securitized assets added back to banks’ risk-weighted assets from Y-

9C reports to estimate the extent of the risk retained. These added securitized assets are neither separately recognized nor disclosed. Thus, my tests of the association between equity risk and the added securitized assets jointly test whether investors can estimate these assets from Y-9C reports and whether investors use the assets to estimate the extent of the risk retained.

If the securitizing bank has provided support beyond the bank’s contractual obligations for its securitized assets, then the bank is required to add the securitized assets back to its risk-weighted assets. To do so, the bank should eliminate those securitized assets from total securitized assets accounted for as sales. Then, by the amount of the eliminated assets, the bank should increase the amount of loans included in the risk- 38 weighted assets. This study uses the positive change in the amount of loans weighted by either 50% or 100% from the HC-R section in the Y-9C report when securitized residential mortgages and/or consumer loans decline at a quarter compared to the previous quarter as an estimate of the increase in banks’ risk-weighted assets arising from the adjustments of formerly off-balance sheet securitized assets (EST_Securitized).21 To test whether investors use these estimated amounts in assessing the extent of the risk retained (H4), this study estimates the relation between σR and EST_Securitized as follows.

σRit+1 = δ0 + δ1EST_Securitizedit + δ2Securitizedit + δ3Retainedit + δControls + νit+1 (3)

H4 predicts that if investors can estimate the amounts of securitized assets added back to banks’ risk-weighted assets and use these amounts to estimate the extent of the risk retained, then δ1 should be positive.

21 Loans can be weighted by between 0% and 200%, depending on the underlying risks of the loans. This study focuses on the loans that 50% or higher weights are assigned because residential mortgages and consumer loans in general are weighted by 50% and 100%, respectively and the non-contractual risk is an issue only for these types of loans (S&P 2009; Chen et al. 2008). 39

Chapter 6. Sample and Descriptive Statistics

This study gathers quarterly data from four sources. I collect quarterly earnings per share necessary to estimate Earn_VOL from Bank Compustat, financial statement and securitization data from the regulatory Y-9C report, and stock returns from CRSP. I also collect CONS_QSPE, CONS_VIE, and UNCONS_QSPE from banks’ 10-K filings for the fiscal year 2009. My sample period spans 2009 to the second quarter of 2012. I stopped collecting data at the second quarter of 2012 because that was the last quarter when the

Y-9C report was available. This study examines investors’ views on asset securitizations.

As such, this study focuses on banks that had positive securitized assets in at least one quarter between 2008 and 2009.

Out of 64 banks with positive securitized assets, three bank holding companies were sold to another company after their wholly owned subsidiary banks went bankrupt.

To mitigate the outlier effects, I exclude these three banks from my sample.22 Then, I require banks to have non-missing values for the variables included in the Baseline, which leaves 196 bank-quarter observations for 49 banks.23 Out of 49 banks, 17 banks have positive CONS_QSPE and/or CONS_VIE. Out of 17 banks, 14 banks (56 bank-

22 The three banks appear to be significantly different from other banks in many dimensions. In particular, the median standard deviation of daily stock returns (σR) for the three banks (8.7) is much larger than that of the upper ten percent of other banks (7.4) (untabulated). 23 See Appendix D for details about sample selection procedures. 40 quarters) have positive CONS_QSPE, and seven banks (28 bank-quarters) have positive

CONS_VIE.24 Out of 49 banks, five banks (20 bank-quarters) have positive

UNCONS_QSPE. CONS_QSPE, CONS_VIE, and UNCONS_QSPE are used for the four quarters of 2009.

Table 1 presents descriptive statistics for the variables used in estimating

Equation (1) through Equation (3). Panel A presents distributional statistics for 2009,

Panel B presents distributional statistics between 2009 and the second quarter of 2012, and Panel C presents Pearson and Spearman correlations. As shown in Panel A, the mean

CONS_Securitized is 0.150, which indicates that about 12 percent of total securitized assets were consolidated back onto firms’ balance sheets upon the adoption of the new standards. CONS_QSPE and CONS_VIE are 0.124 and 0.017, which are about one-tenth and one-hundredth of Securitized, respectively. Untabulated findings also reveal that while about 41 percent of off-balance-sheet QSPE assets are consolidated, only 3 percent of off-balance-sheet VIE assets are consolidated. These findings indicate that the new standards had a much greater impact on QSPE assets than VIE assets.

In Panel B, Securitized declined between 2009 and 2010, but then marginally increased after 2010. Such a sharp decline in securitized assets can be, in part, explained by one-time consolidation effect upon the adoption of the new standards. The marginal increase in securitized assets is mainly attributable to the increase in securitized mortgage loans. SecuritizedMortgage declined from 1.07 to 0.87 between 2009 and 2010, but then increased to 0.90 after 2010. Overall, securitized assets increased even after the new standards became effective, and such an increase raises questions about some criticism

24 Four out of seven banks with positive CONS_VIE also have positive CONS_QSPE. 41 that the new standards for asset securitizations will deter securitizations and consequently lending (Ronen and Subrahmanyam 2010).

Panel C in Table 1 shows that CONS_Securitized is positively correlated with equity risk. CONS_QSPE and CONS_VIE are positively correlated with equity risk though UNCONS_QSPE is also positively correlated. In addition, EST_Securitized is positively correlated with CONS_Securitized (Spearman = 0.61), which suggests that the banking agencies’ assessments of risk associated with securitized assets in part overlap with the analysis required under the new standards. Interestingly, EST_Securitized is also positively correlated with UNCONS_QSPE (Spearman = 0.36), which may suggest that the banking agencies view some of the unconsolidated QSPE assets as posing risk to the securitizing firm.

Table 2 presents distributional statistics for EST_Securitized between 2009 and

2012. In 2009, 16 banks have positive EST_Securitized and 15 out of 16 banks are from my sample. Although the number of banks with positive EST_Securitized declines from

11 to 2 between 2010 and 2012, some banks still have positive EST_Securitized after the new standards became effective. Along with the positive correlation between

EST_Securitized and CONS_Securitized, these univariate analyses overall suggest that the banking agencies’ assessments of the securitizing bank’s off-balance-sheet exposure in part overlap with, but differ from the analysis required under the new standards.

42

Chapter 7. Results

7.1 Tests of H1 - H3

Table 3 presents results from estimating the Baseline, Equation (1), and Equation

(2) between 2009 and 2012. The first set of columns shows that the coefficient on

Securitized is significantly positive (t = 2.19) and the coefficient on Retained is not significant (t = 1.05). The positive coefficient on Securitized suggests that, consistent with prior research, investors assumed that on average firms would provide implicit recourse on securitized assets before SFAS 166 and SFAS 167 became effective, which indicates that investors treated securitizations as borrowings prior to the adoption of the new standards. Regarding control variables, inconsistent with my expectation, the coefficient on ChargeOffs is significantly negative (t = -3.61). As expected, the coefficient on T1_RISK is significantly negative (t = -2.34).

More importantly for my research question, the second set of columns shows that consistent with my prediction in H1, σR is significantly positively associated with

CONS_Securitized beyond total securitized assets (t = 2.19). This positive coefficient indicates that investors anticipated that firms would provide implicit recourse for the consolidated assets before the two new standards became effective. These findings suggest that investors treated the assets as borrowings prior to the adoption of the new standards. Regarding the unconsolidated assets, the coefficient on Securitized is not

43 significant (t = 1.42). This insignificant coefficient provides no evidence that investors treated the unconsolidated assets as borrowings prior to the adoption of the new standards.

Table 3 Column (3) provides test results for H2. I find that σR is significantly positively associated with both CONS_QSPE and CONS_VIE (t = 2.13 and 2.24, respectively). These positive coefficients indicate that before the new standards became effective, investors anticipated that firms would provide implicit recourse for those QSPE and VIE assets that were ex-post consolidated as required by the standards. These findings suggest that investors treated the consolidated QSPE and VIE assets as borrowings prior to the adoption of the new standards. More importantly, inconsistent with my prediction in H2, the t-test shows that the coefficient on CONS_QSPE is not significantly different from the coefficient on CONS_VIE (t = -1.20). These findings indicate that for the consolidated assets there is no evidence that investors distinguished between QSPEs and VIEs with respect to implicit recourse prior to the adoption of the new standards. Regarding the unconsolidated assets, the coefficients on UNCONS_QSPE and Securitized are not significant (t = 1.22 and 0.78, respectively). These insignificant coefficients provide no evidence that investors treated the unconsolidated QSPE and VIE assets as borrowings prior to the adoption of the new standards.

Table 3 Column (4) provides empirical results for testing H3. I find that the coefficient on Securitized is not significant (t = -0.28), and the coefficient on Retained is significantly positive (t = 3.68). These findings provide no evidence that investors continue to treat securitizations as borrowings after the new standards became effective.

Overall, the findings from Table 3 imply that i) investors treated consolidated assets as secured borrowings before SFAS 166 and SFAS 167 became effective, ii) for 44 consolidated assets, there is no evidence that investors distinguished between QSPEs and

VIEs with respect to implicit recourse prior to the adoption of the new standards, and iii) after these assets were consolidated, there is no evidence that investors continue to treat securitizations as borrowings. These findings overall suggest that the new accounting standards are more consistent with equity investors’ views of asset securitizations.

Assuming that the market is correct in assessing the extent of the risk retained, these findings imply that the new VIE accounting is more effective at identifying implicit recourse than the prior QSPE/VIE accounting.

7.2 Tests of H4

Next, I test whether investors can estimate and use the banking agencies’ implicit recourse adjustments in assessing the extent of the risk retained. Table 4 presents results from estimating Equation (3). The first set of columns from Table 3 is included for comparative purposes. Consistent with my prediction in H4, the second set of columns shows that σR is significantly positively associated with EST_Securitized (t = 3.08), which suggests that investors can estimate the increase in banks’ risk-weighted assets arising from the adjustments of formerly off-balance sheet securitized assets and use these added assets to estimate the extent of the risk retained. Put differently, investors’ views about implicit recourse are consistent with the banking agencies’ implicit recourse adjustments.

Interestingly, the coefficient on Securitized remains significantly positive (t = 2.00).

Along with the positive correlation between EST_Securitized and CONS_Securitized, these findings suggest that the banking agencies’ implicit recourse adjustments in part overlap with, but differ from the analysis required under the new standards.

45

An alternative explanation for the positive relation between equity risk and

EST_Securitized is that even though the banking agencies’ implicit recourse adjustments are not associated with implicit risk, investors may price the adjustments if the banking agencies require firms to include the adjustments in calculating their regulatory capital ratio. However, as one of the controls, Equation (3) includes Tier 1 risk-based capital ratio, which captures firms’ regulatory capital risk. In addition, Table 5 shows that

EST_Securitized is not significantly associated with UNCONS_QSPE, but significantly positively associated with CONS_Securitized and CONS_QSPE. Column (1) shows that the coefficient on CONS_Securitized is significantly positive (t = 4.26). Column (2) reports that the coefficient on CONS_QSPE is significantly positive (t = 3.60) whereas the coefficient on UNCONS_QSPE is insignificant (t = -1.17). The t-test shows that the coefficient on CONS_QSPE is also significantly greater than the coefficient on

UNCONS_QSPE (t = 3.68). The coefficient on CONS_VIE is not significant (t = 0.84) though it is not significantly different from the coefficient on CONS_QSPE (t = 0.17).25

These findings indicate that to some degree the banking agencies’ implicit recourse adjustments are consistent with the new standards, which suggests that the adjustments capture the risk associated with implicit recourse at least to the extent that securitized assets consolidated under the new standards are associated with the implicit risk. Overall,

25 The insignificant coefficient may be due to the lack of power and/or the measurement error in CONS_VIE. Seven banks have positive CONS_VIE, which leads to 28 bank-quarter observations. The measurement error could arise from the possible mismatch between the type of consolidated assets and the type of VIE assets. In addition, when firms securitized a type of assets through both QSPEs and VIEs and provides only one aggregate amount of the assets consolidated, I use the outstanding VIE assets as CONS_VIE such that CONS_QSPE is not overstated. However, this approach could understate CONS_QSPE and overstate CONS_VIE. 46 these findings alleviate concern over the regulatory capital risk explanation for the positive relation.

47

Chapter 8. Robustness Tests

Following Chen et al. (2008), I test whether the results from Table 3 are robust to disaggregating total loans (Loans) into the three categories: mortgage loans (MLOANS), consumer loans (CONSLOANS), and commercial loans (COMMLOANS). In Panel A,

Table 6, Column (1) shows that the coefficient on Securitized remains significantly positive. Column (2) shows that the coefficient on CONS_Securitized is not significant at a two-tailed test though it is marginally significant at a one-tailed test. Column (3) shows that the coefficients on CONS_QSPE and CONS_VIE are below the significance level though the coefficient on CONS_VIE is marginally significant at a one-tailed test. These coefficients are not significantly different from each other. The lack of significance of the coefficients on these consolidated assets is not surprising given that they are not broken into the three categories. It is not clear whether the aggregate amounts of consolidated assets correctly capture risk in the assets after controlling for risk differences across the three types of loans. Column (4) shows that the coefficient on Retained remains significantly positive.

Chen et al. (2008) suggest that the investors’ assessments of implicit risk associated with securitizations vary by the type of assets securitized. An alternative explanation for the positive relation between equity risk and the consolidated securitized assets is that the type of securitized assets consolidated as required by the new standards

48 is riskier than that of securitized assets unconsolidated. To rule out this possibility, following Chen et al. (2008), I estimate expanded versions of Equation (1) and Equation

(2), in which I disaggregate Securitized and Retained into the three categories. I also break total loans (Loans) into the three categories to control for any risk differences across the three types of on-balance sheet loans. In Panel B, Table 6, Column (1) shows that the coefficients on SecuritizedMortgage and Securitized Commercial are significantly positive. Column (2) shows that the coefficient on CONS_Securitized is not significant at a two-tailed test though it is marginally significant at a one-tailed test.

Column (3) shows that the coefficients on CONS_QSPE and CONS_VIE are below the significance level though the coefficient on CONS_QSPE is marginally significant at a one-tailed test. Again, given that these consolidated assets are not broken into the three categories, it is not surprising to see the lack of significance of the coefficients on the assets. Overall, the findings from Table 6, though somewhat weak, suggest that the positive relation between equity risk and the consolidated assets is not completely explained by risk differences across different types of securitized loans.

Following Chen et al. (2008), independent variables used in my models are deflated by market value of equity. During the recent financial crisis, firms experienced significant drops in their market value of equity. These drops mechanically inflate the value of the variables and may also significantly increase stock return volatility. As such, if firms that experienced such significant drops had a significant level of consolidated assets, then it is possible that the denominator effect of the variables leads to the positive relation between the volatility and the consolidated assets. To rule out this alternative explanation, I test whether the positive relation is unaffected by using other deflators such 49 as total assets and book value of equity. In Panel A, Table 7, the second and third sets of columns show that using total assets as the deflator, the coefficients on

CONS_Securitized and CONS_QSPE are significantly positive and that the coefficient on

CONS_VIE is marginally insignificant. The magnitude of the coefficients is much larger than that of the coefficients from Table 4. Such larger coefficients are attributable to total assets being much larger than market value of equity. While the median market value of equity for my sample is $0.5 billion, the median total assets are $11.9 billion. In Panel B, the second and third sets of columns show that using book value of equity as the deflator, the coefficients on CONS_Securitized and CONS_QSPE are significantly positive. In short, the possible denominator effect does not explain the positive relation between equity risk and the consolidated assets.

I use 196 observations in my main regression analysis. Given the small sample size, it is possible that my results are driven by a few influential observations. To mitigate this concern, I test whether the results are robust to winsorizing the upper and lower tails of the variables used in the models at 2.5% and also to eliminating outliers following

Belsley et al. (1980). I classify outliers as those observations with studentized residuals greater than 2.5 in absolute value. Table 8 shows that inferences are unchanged. The relation between equity risk and the consolidated securitized assets remains significantly positive, the difference between the coefficients on consolidated QSPE and VIE assets remains insignificant, and the relation between equity risk and the retained interest in securitized assets between 2010 and 2012 remains significantly positive.

50

Chapter 9. Conclusion

Prior research examines how investors view asset securitizations, and indicates that investors treat securitizations as borrowings even when GAAP treats them as sales.

Concerns about the accounting for asset securitizations led the FASB to issue two new accounting standards. Upon the adoption of these new rules, some off-balance-sheet securitized assets were consolidated back onto firms’ balance sheets. This study examines whether the new accounting standards result in financial reporting that is more aligned with investors’ views of asset securitizations. To address this question, this study investigates how investors viewed previously off-balance-sheet securitized assets before the two new standards became effective. In doing so, it separately examines assets that firms consolidated under the new standards and those that firms left unconsolidated. This study also examines whether, for assets consolidated under the new standards, investors distinguished between securitizations going through two different accounting structures prior to the adoption of the standards.

I find that investors treated the consolidated assets as secured borrowings before the new standards became effective, that for the consolidated assets, there is no evidence that investors distinguished between securitizations going through two different structures prior to the adoption of the new standards, and that after the assets were consolidated, there is no evidence that investors continue to treat securitizations as borrowings. These findings overall suggest that the new accounting standards are more

51 consistent with investors’ views of asset securitizations. Assuming that investors can accurately assess the risk in securitizations, the findings imply that the new accounting standards better reflect the economics of securitization transactions, which is consistent with the FASB’s main objective for adopting the standards.

While I focus on securitizations sponsored by banks, there is no obvious reason why investors of non-banks would have different views on the distinction between securitizations that were consolidated and unconsolidated as required by the new standards if they were able to draw the distinction. Prior studies document that investors of non-banks have similar views on securitizations compared to those of banks. However, my findings may be limited to banks because there are disclosures available only in the banking industry (e.g., Y-9C regulatory reports). If these disclosures are the only sources that investors can use to draw the distinction, then investors of non-banks may not be able to distinguish between these different types of securitizations. Rather, they may treat all securitizations as borrowings. Given these possibilities, it is interesting to examine whether my results hold for non-banks and if so, how investors of non-banks would have distinguished between securitizations that are borrowings versus sales.

To address these questions, a research design similar to my study can be employed. We need to test how investors of non-financial firms priced risk in the consolidated assets versus the unconsolidated assets and to explore possible information sources that investors could have used to draw such a distinction. However, because securitized assets are not recognized and there are no such regulatory reports for non- financial firms, we may need to rely on hand-collected data from the financial reports for a relatively small sample. Requiring firms to have positive consolidated assets will 52 further reduce the already small sample. As such, it may not be feasible to conduct the tests.

53

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Appendix A: Accounting Standards for Asset Securitizations

Effective Exposure Draft Issued FSP SFAS 166 FAS 140 SFAS 166 FAS140-4 & & & & FIN46(R)-8 SFAS 167 SFAS 167 SFAS 140 FIN 46(R) FIN 46(R)

58

MAR 2001 DEC 2003 SEP 2008 DEC 2008 JUN 2009 NOV 2009

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Appendix B: 10-K filings Examples - Impact of SFAS 166 and 167

A) FIRST CITIZENS BANCSHARES, INC. : CONS_QSPE = $97,291 & CONS_VIE = $0 In 2005, FCB securitized and sold approximately $250,000 of revolving mortgage loans through the use of a QSPE. The analysis of this QSPE under the new accounting guidance determined that the financial assets of the VIE should be included in the consolidated financial statements. This consolidation will become effective in the first quarter of 2010 and will result in an increase in loans and debt in an amount equal to the fair value of the instrument at time of consolidation. The balance of these loans and the corresponding debt obligation as of December 31, 2009 is $97,291 and $85,849, respectively.

B) BANK OF AMERICA CORPORATION : CONS_QSPE = $70 billion & CONS_VIE = $30 billion The adoption of this new accounting guidance resulted in a net incremental increase in assets, on a preliminary basis, of approximately $100 billion, including $70 billion resulting from consolidation of credit card trusts and $30 billion from consolidation of other special purpose entities (SPEs) including multi-seller conduits.

The Corporation securitizes, sells and services interests in residential mortgage loans and credit card loans, and from time to time, automobile, other consumer and commercial loans. The securitization vehicles are typically QSPEs which, in accordance with applicable accounting guidance, are legally isolated, bankruptcy remote and beyond the control of the seller, and are not consolidated in the Corporation’s Consolidated Financial Statements.

Other special purpose financing entities (e.g., Corporation-sponsored multi-seller conduits, collateralized debt obligation vehicles and asset acquisition conduits) are generally funded with short-term commercial paper or long- term debt. For non-QSPE structures or VIEs, the Corporation assesses whether it is the primary beneficiary of the entity.

C) BANCORPSOUTH, INC. : CONS_QSPE = $0 & CONS_VIE = $0 In June 2009, the FASB issued a new accounting standard regarding accounting for transfers of financial assets. The Company believes that the adoption of this new accounting standard regarding accounting for transfers of financial assets will have no material impact on the financial position or results of operations of the Company.

In June 2009, the FASB issued a new accounting standard regarding consolidation of variable interest entities. The Company believes that the adoption of this new accounting standard regarding consolidation of variable interest entities will have no material impact on the financial position or results of operations of the Company.

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Appendix C: Variable Definitions

Dependent Variables

σR standard deviation of daily returns for the following quarter

Experimental Variables consolidated securitized assets, which is defined as the amount of securitized assets CONS_Securitized that were consolidated upon the adoption of SFAS 166 and SFAS 167, divided by market value of equity consolidated QSPE assets, which is defined as the amount of securitized assets sold to CONS_QSPE QSPEs that were consolidated upon the adoption of SFAS 166 and SFAS 167, divided by market value of equity consolidated VIE assets, which is defined as the amount of securitized assets sold to VIEs CONS_VIE that were consolidated upon the adoption of SFAS 166 and SFAS 167, divided by market value of equity estimated securitized assets, which is defiend as the amount of securitized assets estimated EST_Securitized from the Y-9C report that were added back into banks' risk-weighted assets unconsolidated QSPE assets, which is defined as the amount of outstanding securitized assets UNCONS_QSPE sold to QSPEs that were not consolidated upon the adoption of SFAS 166 and SFAS 167, divided by market value of equity Securitized total securitized assets divided by market value of equity Retained total retained interest in securitized assets divided by market value of equity SecuritizedMortgage securitized 1-4 family residential mortgages divided by market value of equity securitized consumer loans (home equity lines of credit, credit card receivables, automobile SecuritizedConsumer loans, and other consumer loans) divided by market value of equity securitized commercial loans (commercial and industrial loans and all other loans, leases, and SecuritizedCommercial assets) divided by market value of equity RetainedMortgage retained interest from mortgage securitizations divided by market value of equity RetainedConsumer retained interest from consumer loan securitizations divided by market value of equity RetainedCommercial retained interest from commercial loan securitizations divided by market value of equity

Control Variables Earn_VOL standard deviation of earnings per share for past six quarters absolute value of difference between book values of assets and liabilities expected to reprice GAP in the following quarter divided by market value of equity sum of cash, available-for-sale securities, trading assets, federal funds sold, and securities LiquidAssets purchased with intent to resell, scaled by market value of equity

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the sum of available-for-sale and held-to-maturity securities minus retained interest divided Securities by total assets Size natural logarithm of total assets MLOANS mortgage loans outstanding divided by market value of equity COMMLOANS commercial loans outstanding divided by market value of equity CONSLOANS consumer loans outstanding divided by market value of equity Loans total loans divided by market value of equity ChargeOffs net loan charge-offs divided by market value of equity PastDue past due and non-accruing loans divided by market value of equity IntDeriv notional amount of interest rate derivatives divided by market value of equity TRADINC trading income during quarter divided by market value of equity SECINC servicing fee and securitization income during quarter divided by market value of equity T1_RISK Tier 1 risk-based capital ratio AssetGrowth percentage growth in managed asset (asset plus total securitized assets) for the quarter

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Appendix D: Sample Selection Procedures

# of Bank # of Quarter

(1) Positive securitized assets, at least once between 2008 and 2009 64

(2) Exclude banks that went bankrupt between 2009 and 2012 61

(3) Non-missing variables 49 196 Consolidated no assets 32 128 Consolidated only QSPE assets 10 40 Consolidated only VIE assets 3 12 Consolidated both QSPE and VIE assets 4 16

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Appendix E: Tables

Table 1. Descriptive Statistics

This table reports descriptive statistics for the variables used in the Baseline and Equation (1) through Equation (3). Panel A and Panel B present descriptive statistics for 2009 and between 2009 and 2012, respectively. Panel C reports Pearson and Spearman correlations. See Appendix C for variable definitions.

Panel A. 2009 (49 banks - 196 observations)

Variables Mean Min 25th 50th 75th Max Std. Dev

σR 3.9913 1.0032 2.3939 3.4646 5.1565 10.145 2.0399 CONS_Securitized 0.1504 0 0 0 0.1016 1.4511 0.3183 CONS_QSPE 0.1236 0 0 0 0.0634 1.2092 0.2844 CONS_VIE 0.0171 0 0 0 0 0.2418 0.0524 UNCONS_QSPE 0.1815 0 0 0 0 4.9124 0.7582 EST_Securitized 0.1806 0 0 0 0.0653 2.7751 0.4590 Securitized 1.2717 0 0 0.0553 0.8026 14.097 2.9646 Retained 0.0633 0 0 0 0.0035 1.7501 0.2662 SecuritizedMortgage 1.0751 0 0 0.0053 0.4179 12.838 2.7286 SecuritizedConsumer 0.0745 0 0 0 0.0000 0.8501 0.1996 SecuritizedCommercial 0.0762 0 0 0 0.0036 1.1644 0.2248 RetainedMortgage 0.0369 0 0 0 0.0000 1.7501 0.2480 RetainedConsumer 0.0140 0 0 0 0 0.2320 0.0473 RetainedCommercial 0.0017 0 0 0 0 0.0765 0.0085 Earn_VOL 0.9575 0.0172 0.1786 0.5129 1.3420 3.7418 1.0608 LiquidAssets 5.9704 0.7199 2.4353 3.8064 6.2970 84.754 7.9623 Securities 0.1738 0.0265 0.1164 0.1502 0.2101 0.6220 0.0969 Size 16.382 13.341 14.621 16.286 17.804 21.546 2.1293 ChargeOffs 0.2739 0.0007 0.0310 0.0953 0.2759 9.7627 0.7857 PastDue 1.3682 0.0407 0.2337 0.6541 1.1379 32.364 2.9018 IntDeriv 25.138 0 0.1615 1.3010 8.9976 547.80 94.384 TRADINC 0.0095 -0.0011 0 0 0.0066 0.1284 0.0233 SECINC 0.0075 -0.0151 0 0.0013 0.0072 0.0641 0.0148 T1_RISK 12.182 4.8800 10.535 11.840 13.370 20.310 2.3540 GAP 3.8554 0.0367 1.0395 2.4643 4.4390 36.836 4.7418 Loans 17.858 1.2194 6.6523 11.269 20.820 241.90 22.613 AssetGrowth 0.4722 -8.3751 -2.1533 -0.3719 1.5315 29.016 5.6711

Continued

63

Table 1 Continued

Panel B. 2009 & 2010 - 2012

2009 2010 2011 - 2012 Variables N Mean N Mean N Mean

σR 196 3.9913 192 2.9514 222 2.8317 Securitized 196 1.2717 192 0.9559 222 0.9734 Retained 196 0.0633 192 0.0283 222 0.0320 SecuritizedMortgage 196 1.0751 192 0.8700 222 0.9086 SecuritizedConsumer 196 0.0745 192 0.0032 222 0.0074 SecuritizedCommercial 196 0.0762 192 0.0745 222 0.0575 RetainedMortgage 196 0.0369 192 0.0257 222 0.0301 RetainedConsumer 196 0.0140 192 0.0001 222 0.0001 RetainedCommercial 196 0.0017 192 0.0025 222 0.0017

Continued

64

Table 1 Continued

Panel C. Pearson (Above) and Spearman (Below) Correlations

Variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) (17) (18) (19)

(1) σR 0.21 0.18 0.12 0.12 0.21 0.11 0.09 0.27 0.54 -0.06 -0.21 0.41 0.51 -0.02 -0.05 0.13 -0.33 0.50 (2) CONS_Securitized 0.10 0.96 0.36 0.14 0.35 0.15 0.11 0.07 0.00 -0.13 0.22 -0.02 -0.03 0.25 0.24 0.17 -0.13 0.12 (3) CONS_QSPE 0.09 0.90 0.16 0.15 0.32 0.10 0.10 0.05 0.00 -0.12 0.20 -0.02 -0.03 0.24 0.25 0.14 -0.13 0.10 (4) CONS_VIE 0.04 0.62 0.36 0.10 0.14 0.34 0.07 0.12 0.00 -0.09 0.25 -0.01 -0.02 0.19 0.14 0.30 -0.10 0.10 (5) UNCONS_QSPE 0.06 0.40 0.32 0.66 0.00 0.32 0.48 0.00 0.02 -0.08 0.20 -0.01 0.01 0.16 0.12 0.15 -0.12 0.05 (6) EST_Securitized 0.09 0.61 0.61 0.37 0.36 0.06 0.00 0.23 -0.02 -0.08 0.15 -0.02 -0.03 0.02 0.04 0.12 -0.11 0.14 (7) Securitized 0.05 0.24 0.20 0.24 0.25 0.24 0.35 -0.03 0.16 -0.08 0.33 0.12 0.15 0.27 0.46 0.52 -0.06 0.21 (8) Retained 0.01 0.47 0.43 0.37 0.38 0.54 0.50 0.00 0.01 -0.16 0.15 0.00 0.01 0.12 0.12 0.10 -0.05 0.04 (9) Earn_VOL 0.27 0.18 0.16 0.11 0.12 0.21 0.17 0.12 0.28 -0.03 -0.04 0.29 0.29 -0.07 -0.08 0.09 -0.12 0.35 (10) LiquidAssets 0.50 0.08 0.08 0.06 0.10 0.06 0.22 0.14 0.35 0.10 -0.11 0.89 0.94 0.06 0.00 0.40 -0.32 0.79 (11) Securities -0.08 -0.19 -0.16 -0.11 -0.10 -0.19 -0.06 -0.25 -0.11 0.26 -0.14 -0.02 -0.01 -0.10 -0.12 -0.03 0.52 -0.11 65 (12) Size -0.24 0.33 0.28 0.30 0.24 0.38 0.30 0.53 0.03 -0.14 -0.16 -0.11 -0.13 0.54 0.41 0.34 -0.20 0.08 (13) ChargeOffs 0.40 0.16 0.12 0.12 0.11 0.17 0.17 0.22 0.42 0.44 -0.28 0.08 0.92 -0.02 -0.04 0.39 -0.35 0.75 (14) PastDue 0.53 0.13 0.09 0.12 0.13 0.15 0.27 0.20 0.52 0.59 -0.32 -0.04 0.74 -0.03 -0.06 0.35 -0.36 0.74 (15) IntDeriv -0.01 0.28 0.23 0.29 0.21 0.29 0.33 0.46 0.13 0.12 -0.24 0.71 0.30 0.24 0.56 0.34 -0.13 0.09 (16) TRADINC -0.12 0.29 0.27 0.24 0.21 0.31 0.30 0.48 0.04 -0.01 -0.27 0.66 0.15 0.03 0.61 0.56 -0.05 0.08 (17) SECINC 0.05 0.20 0.20 0.21 0.26 0.32 0.45 0.35 0.08 0.10 -0.08 0.37 0.33 0.32 0.38 0.31 -0.21 0.41 (18) T1_RISK -0.25 -0.22 -0.19 -0.20 -0.19 -0.21 -0.13 -0.22 -0.14 -0.07 0.35 -0.23 -0.34 -0.32 -0.41 -0.28 -0.23 -0.39 (19) GAP 0.27 0.16 0.12 0.14 0.12 0.22 0.18 0.31 0.27 0.43 -0.23 0.30 0.58 0.57 0.49 0.29 0.33 -0.40

65

Table 2. Distribution of Estimated SPE Assets (EST_Securitized)

Table 2 reports distribution of the amount of securitized assets estimated from the Y-9C report that were added back to banks' risk-weighted assets for regulatory capital purposes (EST_Securitized). See Appendix C for variable definitions.

EST_Securitized > 0 Year # of Bank EST_Securitized 2009 16 0.576 2010 11 0.146 2011 5 0.080 2012 2 0.074

EST_Securitized > 0 Sample Banks Non-Sample Banks Year # of Bank EST_Securitized # of Bank EST_Securitized 2009 15 0.590 1 0.153 2010 11 0.146 0 0 2011 4 0.052 1 0.251 2012 2 0.074 0 0

66

Table 3. Relation between Equity Risk (σR) and QSPE and VIE Assets

Table 3 reports regression results of one-quarter-ahead standard deviation of daily stock returns (σR) between 2009 and the second quarter of 2012 as estimated in the Baseline, Equation (1), and Equation (2). Please refer to Appendix C for description of all the variables. *, **, *** denotes significance at the p<0.10, p<0.05, and p<0.01 level respectively. T-statistics are based on standard errors clustered by firm.

2009 2010 - 2012 (1) (2) (3) (4) Baseline H1 H2 H3 Coef. t-stat Coef. t-stat Coef. t-stat Coef. t-stat CONS_Securitized 1.420 2.19 ** CONS_QSPE 1.368 2.13 ** CONS_VIE 4.078 2.24 ** UNCONS_QSPE 0.125 1.22 Securitized 0.064 2.19 ** 0.042 1.42 0.024 0.78 -0.014 -0.28 Retained 0.220 1.05 0.173 0.93 0.132 0.68 0.689 3.68 *** Earn_VOL 0.143 0.77 0.196 1.11 0.148 0.84 0.129 0.90 LiquidAssets 0.056 1.53 0.056 1.58 0.061 1.64 0.024 0.69 Securities 0.218 0.12 0.038 0.02 0.104 0.06 0.187 0.12 Size -0.127 -1.05 -0.126 -1.12 -0.153 -1.21 -0.150 -1.66 ChargeOffs -1.516 -3.61 *** -1.634 -4.46 *** -1.612 -4.46 *** -0.294 -1.60 PastDue 0.164 0.80 0.345 1.69 * 0.305 1.54 -0.054 -0.35 IntDeriv -0.001 -0.73 -0.002 -1.56 -0.002 -1.76 * 0.001 1.63 TRADINC 1.018 0.20 1.541 0.32 2.539 0.51 5.003 1.07 SECINC -7.979 -1.12 -3.619 -0.54 -6.051 -0.87 -1.405 -0.11 T1_RISK -0.151 -2.34 ** -0.162 -2.69 *** -0.148 -2.46 ** -0.053 -1.26 GAP 0.054 0.99 0.043 0.85 0.033 0.62 -0.023 -0.33 Loans 0.036 1.34 0.015 0.53 0.021 0.79 0.035 1.39 AssetGrowth -0.019 -1.06 -0.021 -1.13 -0.023 -1.23 -0.018 -1.36 Constant 8.300 3.48 *** 8.618 3.79 *** 8.780 3.60 *** 5.252 2.89 ***

t-test

CONS_QSPE = CONS_VIE -2.710 -1.20

FE Quarter Quarter Quarter Quarter & Year

# of Obs. 196 196 196 414 Adj. Rsq. 0.6738 0.6928 0.6910 0.5591

67

Table 4. Relation between Equity Risk (σR) and Estimated SPE Assets (EST_Securitized)

Table 4 reports regression results of one-quarter-ahead standard deviation of daily stock returns (σR) for 2009 as estimated in the Baseline and Equation (3). Please refer to Appendix C for description of all the variables. *, **, *** denotes significance at the p<0.10, p<0.05, and p<0.01 level respectively. T-statistics are based on standard errors clustered by firm.

2009 (1) (2) Baseline H4 Coef. t-stat Coef. t-stat EST_Securitized 0.734 3.08 *** Securitized 0.064 2.19 ** 0.062 2.00 * Retained 0.220 1.05 0.239 1.11 Earn_VOL 0.143 0.77 0.065 0.38 LiquidAssets 0.056 1.53 0.065 1.81 * Securities 0.218 0.12 -0.062 -0.04 Size -0.127 -1.05 -0.137 -1.19 ChargeOffs -1.516 -3.61 *** -1.586 -4.09 *** PastDue 0.164 0.80 0.248 1.24 IntDeriv -0.001 -0.73 0.000 -0.35 TRADINC 1.018 0.20 3.485 0.72 SECINC -7.979 -1.12 -12.28 -1.56 T1_RISK -0.151 -2.34 ** -0.154 -2.59 ** GAP 0.054 0.99 0.032 0.60 Loans 0.036 1.34 0.029 1.08 AssetGrowth -0.019 -1.06 -0.019 -1.05 Constant 8.300 3.48 *** 8.561 3.71 ***

FE Quarter Quarter

# of Obs. 196 196 Adj. Rsq. 0.6738 0.6925

68

Table 5. Relation between Estimated SPE Assets (EST_Securitized) and Consolidated Securitized Assets (CONS_Securitized)

Table 5 reports results from regressing estimated securitized assets (EST_Securitized) on consolidated securitized assets (CONS_Securitized) in Column (1) and on consolidated QSPE assets (CONS_QSPE), consolidated VIE assets (CONS_VIE), and unconsolidated QSPE assets (UNCONS_QSPE) in Column (2). Please refer to Appendix C for description of all the variables. *, **, *** denotes significance at the p<0.10, p<0.05, and p<0.01 level respectively.

2009 (1) (2) Coef. t-stat Coef. t-stat CONS_Securitized 0.439 4.26 *** CONS_QSPE 0.406 3.60 *** CONS_VIE 0.512 0.84 UNCONS_QSPE -0.050 -1.17 Constant 0.121 3.52 *** 0.131 3.58 ***

t-test

CONS_QSPE = CONS_VIE -0.105 -0.17 CONS_QSPE = UNCONS_QSPE 0.456 3.68 *** CONS_VIE = UNCONS_QSPE 0.561 0.91

# of Obs. 196 196 Adj. Rsq. 0.0810 0.0572

69

Table 6. Relation between Equity Risk (σR) and QSPE and VIE Assets beyond the Type of Assets

Table 6 reports regression results of one-quarter-ahead standard deviation of daily stock returns (σR) for 2009 as estimated in expanded versions of the Baseline, Equation (1), and Equation (2). Panel A reports results from the regression that disaggregates total loans (Loans) into three categories: mortgage loans (MLOANS), consumer loans (CONSLOANS), and commercial loans (COMMLOANS). Panel B presents regression results further breaking Securitized and Retained into three categories: residential mortgages, consumer loans, and commercial loans. Please refer to Appendix C for description of all the variables. *, **, *** denotes significance at the p<0.10, p<0.05, and p<0.01 level respectively. T-statistics are based on standard errors clustered by firm.

Panel A. Disaggregation of Loans into Three Categories

2009 2010 - 2012 (1) (2) (3) (4) Coef. t-stat Coef. t-stat Coef. t-stat Coef. t-stat CONS_Securitized 1.033 1.38 CONS_QSPE 0.966 1.25 CONS_VIE 3.339 1.65 UNCONS_QSPE 0.139 1.32 Securitized 0.066 2.03 ** 0.051 1.61 0.029 0.97 0.006 0.13 Retained 0.198 0.94 0.185 0.96 0.070 0.33 0.547 3.29 *** Earn_VOL 0.188 1.01 0.208 1.17 0.180 0.98 0.106 0.70 LiquidAssets 0.054 1.57 0.055 1.62 0.058 1.65 0.006 0.22 Securities 0.418 0.23 0.197 0.12 0.279 0.16 0.414 0.26 Size -0.172 -1.60 -0.152 -1.49 -0.188 -1.63 -0.130 -1.39 ChargeOffs -1.332 -3.16 *** -1.475 -3.70 *** -1.444 -3.75 *** -0.466 -2.08 ** PastDue 0.298 1.43 0.394 1.73 * 0.350 1.64 -0.065 -0.47 IntDeriv 0.000 0.19 -0.001 -0.79 -0.001 -0.89 0.001 0.94 TRADINC -2.558 -0.51 -1.236 -0.25 0.309 0.06 5.245 1.19 SECINC -1.369 -0.22 -0.475 -0.08 -2.109 -0.30 -4.622 -0.39 T1_RISK -0.142 -2.22 ** -0.151 -2.57 ** -0.143 -2.44 ** -0.051 -1.18 GAP 0.020 0.42 0.024 0.46 0.016 0.31 0.016 0.32 MLOANS -0.005 -0.20 -0.008 -0.32 -0.003 -0.13 0.064 1.83 * COMMLOANS 0.241 2.88 *** 0.165 1.65 0.165 1.55 -0.157 -1.38 CONSLOANS -0.082 -0.48 -0.086 -0.50 -0.039 -0.21 0.165 1.37 AssetGrowth -0.022 -1.28 -0.023 -1.28 -0.024 -1.32 -0.017 -1.44 Constant 8.880 4.18 *** 8.835 4.31 *** 9.233 4.14 *** 4.897 2.60 **

t-test

CONS_QSPE = CONS_VIE -2.373 -1.34

FE Quarter Quarter Quarter Quarter & Year

# of Obs. 196 196 196 414 Adj. Rsq. 0.7236 0.7319 0.7326 0.6002

Continued

70

Table 6 Continued

Panel B. Disaggregation of Securitized Assets and Loans into Three Categories

2009 (1) (2) (3) Coef. t-stat Coef. t-stat Coef. t-stat CONS_Securitized 1.163 1.32 CONS_QSPE 1.139 1.30 CONS_VIE 2.628 0.98 UNCONS_QSPE 0.063 0.36 SecuritizedMortgage 0.062 1.71 * 0.046 1.33 0.038 0.89 SecuritizedConsumer 1.229 1.32 0.892 0.94 0.833 0.76 SecuritizedCommercial 0.714 1.72 * 0.524 1.88 * 0.440 0.84 RetainedMortgage 0.320 1.61 0.319 1.81 * 0.265 0.82 RetainedConsumer 1.763 0.52 0.501 0.18 1.337 0.26 RetainedCommercial -20.76 -2.54 ** -27.33 -2.56 ** -26.22 -2.22 ** Earn_VOL 0.179 0.98 0.198 1.12 0.167 0.92 LiquidAssets 0.066 1.72 * 0.066 1.78 * 0.067 1.77 * Securities 0.090 0.05 -0.115 -0.07 0.016 0.01 Size -0.187 -1.66 -0.168 -1.60 -0.190 -1.62 ChargeOffs -1.349 -2.77 *** -1.489 -3.47 *** -1.488 -3.52 *** PastDue 0.348 1.46 0.430 1.81 * 0.389 1.71 * IntDeriv -0.002 -1.20 -0.003 -1.44 -0.003 -1.28 TRADINC -0.900 -0.17 0.577 0.13 1.051 0.20 SECINC -2.043 -0.34 -1.633 -0.28 -2.509 -0.34 T1_RISK -0.149 -2.22 ** -0.161 -2.68 ** -0.155 -2.55 ** GAP 0.018 0.36 0.022 0.43 0.011 0.22 MLOANS -0.012 -0.46 -0.013 -0.53 -0.007 -0.27 COMMLOANS 0.242 2.95 *** 0.169 1.72 * 0.163 1.53 CONSLOANS -0.168 -0.89 -0.157 -0.84 -0.102 -0.52 AssetGrowth -0.021 -1.27 -0.021 -1.22 -0.022 -1.24 Constant 9.282 4.38 *** 9.262 4.50 *** 9.465 4.29 *** t-test

CONS_QSPE = CONS_VIE -1.489 -0.56

FE Quarter Quarter Quarter

# of Obs. 196 196 196 Adj. Rsq. 0.6944 0.7028 0.6991

71

Table 7. Relation between Equity Risk (σR) and QSPE and VIE Assets Using Other Deflators

Table 7 reports regression results of one-quarter-ahead standard deviation of daily stock returns (σR) for 2009 as estimated in the Baseline, Equation (1), and Equation (2) using other deflators as total assets in Panel A and book value of equity in Panel B. Please refer to Appendix C for description of all the variables. *, **, *** denotes significance at the p<0.10, p<0.05, and p<0.01 level respectively. T-statistics are based on standard errors clustered by firm.

Panel A. Deflated by Total Assets 2009 (1) (2) (3) Coef. t-stat Coef. t-stat Coef. t-stat CONS_Securitized 31.08 2.57 ** CONS_QSPE 29.88 2.53 ** CONS_VIE 52.42 1.65 UNCONS_QSPE -1.442 -0.63 Securitized 0.899 2.54 ** 0.980 3.20 *** 0.904 2.44 ** Retained -3.065 -0.51 -3.984 -0.72 -1.727 -0.34 Earn_VOL 0.191 1.20 0.223 1.36 0.190 1.18 LiquidAssets -5.634 -0.89 -3.670 -0.73 -3.139 -0.59 Securities 1.760 0.70 1.369 0.64 1.496 0.72 Size -0.277 -3.29 *** -0.317 -3.78 *** -0.313 -3.01 *** ChargeOffs 6.213 0.23 -5.950 -0.30 -5.603 -0.29 PastDue 34.35 6.42 *** 35.60 7.48 *** 35.41 7.14 *** IntDeriv 0.033 1.14 -0.005 -0.17 -0.005 -0.16 TRADINC -85.22 -1.43 -96.06 -1.45 -86.83 -1.17 SECINC -261.7 -2.27 ** -267.4 -2.53 ** -261.4 -2.50 ** T1_RISK -0.169 -3.41 *** -0.174 -3.68 *** -0.178 -3.65 *** GAP 1.013 0.71 1.457 1.00 1.172 0.81 Loans -6.790 -1.46 -5.704 -1.55 -5.193 -1.30 AssetGrowth -0.004 -0.24 -0.011 -0.66 -0.011 -0.67 Constant 15.89 3.31 *** 15.11 3.92 *** 14.67 3.39 ***

t-test

CONS_QSPE = CONS_VIE -22.54 -0.54

FE Quarter Quarter Quarter

# of Obs. 196 196 196 Adj. Rsq. 0.6702 0.6919 0.6892

Continued

72

Table 7 Continued

Panel B. Deflated by Book Value of Equity

2009 (1) (2) (3) Coef. t-stat Coef. t-stat Coef. t-stat CONS_Securitized 3.472 1.85 * CONS_QSPE 3.505 1.68 * CONS_VIE 4.222 1.23 UNCONS_QSPE -0.348 -1.78 * Securitized 0.093 1.40 0.084 1.62 0.108 1.68 * Retained -0.760 -1.35 -0.973 -1.73 * -0.519 -1.02 Earn_VOL 0.285 1.98 * 0.318 2.21 ** 0.273 1.95 * LiquidAssets -0.037 -0.29 -0.016 -0.15 -0.006 -0.05 Securities 1.035 0.40 0.528 0.24 0.704 0.31 Size -0.238 -2.40 ** -0.263 -2.62 ** -0.237 -2.05 ** ChargeOffs -0.954 -0.50 -1.551 -0.97 -1.649 -1.08 PastDue 3.681 8.62 *** 3.827 9.99 *** 3.800 9.81 *** IntDeriv 0.001 0.43 -0.002 -0.65 -0.002 -0.56 TRADINC -8.370 -1.01 -6.788 -0.79 -8.986 -0.97 SECINC -32.97 -2.31 ** -30.17 -2.22 ** -26.81 -1.93 * T1_RISK -0.208 -3.00 *** -0.218 -3.36 *** -0.215 -3.32 *** GAP 0.037 0.30 0.088 0.70 0.065 0.52 Loans -0.291 -2.45 ** -0.332 -3.07 *** -0.303 -2.77 *** AssetGrowth -0.004 -0.24 -0.010 -0.54 -0.010 -0.56 Constant 12.74 4.98 *** 13.45 5.32 *** 12.82 4.69 ***

t-test

CONS_QSPE = CONS_VIE -0.716 -0.14

FE Quarter Quarter Quarter

# of Obs. 196 196 196 Adj. Rsq. 0.6481 0.6644 0.6638

73

Table 8. Relation between Equity Risk (σR) and QSPE and VIE Assets beyond Influential Observations

Table 8 reports regression results of one-quarter-ahead standard deviation of daily stock returns (σR) between 2009 and the second quarter of 2012 as estimated in the Baseline, Equation (1), and Equation (2) beyond influential observations. Panel A reports the regression results winsorizing variables at 2.5%. Panel B presents the regression results eliminating observations with absolute values of studentized residuals greater than 2.5. Please refer to Appendix C for description of all the variables. *, **, *** denotes significance at the p<0.10, p<0.05, and p<0.01 level respectively. T-statistics are based on standard errors clustered by firm.

Panel A. Winsorization of Variables at 2.5%

2009 2010 - 2012 (1) (2) (3) (4) Coef. t-stat Coef. t-stat Coef. t-stat Coef. t-stat CONS_Securitized 1.934 2.11 ** CONS_QSPE 1.599 1.94 * CONS_VIE 5.241 1.93 * UNCONS_QSPE 0.123 0.76 Securitized 0.081 1.96 * 0.067 1.61 0.062 1.52 -0.041 -0.77 Retained 0.217 0.49 -0.083 -0.18 -0.010 -0.02 1.240 3.22 *** Earn_VOL 0.005 0.03 0.071 0.43 0.017 0.11 0.135 0.98 LiquidAssets 0.090 2.69 *** 0.087 2.53 ** 0.093 2.66 ** 0.085 1.35 Securities -0.718 -0.37 -0.491 -0.26 -0.529 -0.27 -0.819 -0.47 Size -0.159 -1.42 -0.172 -1.61 -0.197 -1.55 -0.065 -0.86 ChargeOffs -0.383 -0.56 -0.684 -1.14 -0.573 -0.97 -0.203 -0.39 PastDue 0.060 0.33 0.236 1.20 0.177 0.96 -0.231 -1.39 IntDeriv -0.001 -1.18 -0.003 -1.80 * -0.003 -2.11 ** 0.000 -0.28 TRADINC -1.181 -0.16 0.741 0.10 0.426 0.05 4.847 1.03 SECINC -9.750 -1.32 -6.395 -0.87 -10.63 -1.23 13.54 1.64 T1_RISK -0.133 -2.08 ** -0.157 -2.64 ** -0.138 -2.31 ** -0.032 -0.83 GAP 0.108 2.84 *** 0.094 2.37 ** 0.085 1.89 * -0.060 -1.01 Loans 0.015 0.74 -0.004 -0.16 0.004 0.21 0.057 2.43 ** AssetGrowth -0.036 -1.55 -0.040 -1.63 -0.043 -1.76 * -0.018 -1.28 Constant 8.845 3.93 *** 9.463 4.35 *** 9.530 3.94 *** 3.590 2.40 **

t-test

CONS_QSPE = CONS_VIE -3.642 -1.32

FE Quarter Quarter Quarter Quarter & Year

# of Obs. 196 196 196 414 Adj. Rsq. 0.6993 0.7171 0.7130 0.6054

Continued

74

Table 8 Continued

Panel B. Elimination of Observations with Absolute Values of Studentized Residuals Greater than 2.5

2009 2010 - 2012 (1) (2) (3) (4) Coef. t-stat Coef. t-stat Coef. t-stat Coef. t-stat CONS_Securitized 0.834 2.18 ** CONS_QSPE 0.719 1.97 * CONS_VIE 2.405 1.76 * UNCONS_QSPE 0.087 0.91 Securitized 0.036 1.56 0.026 1.07 0.014 0.48 -0.018 -0.44 Retained 0.165 1.06 0.149 0.93 0.105 0.59 0.737 5.16 *** Earn_VOL 0.028 0.18 0.071 0.47 0.038 0.26 0.061 0.58 LiquidAssets 0.066 2.09 ** 0.063 2.08 ** 0.066 2.11 ** 0.018 0.84 Securities -0.183 -0.13 -0.221 -0.17 -0.201 -0.15 -0.327 -0.30 Size -0.067 -0.78 -0.067 -0.81 -0.085 -0.92 -0.043 -0.60 ChargeOffs -0.831 -2.09 ** -0.950 -2.40 ** -0.893 -2.34 ** -0.012 -0.09 PastDue 0.132 0.74 0.244 1.19 0.210 1.09 -0.242 -2.13 ** IntDeriv -0.001 -1.51 -0.002 -2.32 ** -0.002 -2.40 ** 0.001 1.34 TRADINC 0.678 0.18 0.940 0.28 1.685 0.48 2.841 1.13 SECINC -4.516 -0.79 -2.194 -0.37 -3.826 -0.67 4.593 0.62 T1_RISK -0.092 -1.92 * -0.101 -2.18 ** -0.092 -1.97 * -0.004 -0.12 GAP 0.120 4.10 *** 0.109 3.66 *** 0.104 3.30 *** -0.037 -0.72 Loans 0.028 1.22 0.016 0.62 0.020 0.83 0.067 2.97 *** AssetGrowth -0.015 -1.05 -0.017 -1.18 -0.018 -1.22 -0.017 -1.74 * Constant 6.718 3.97 *** 6.930 4.18 *** 7.064 3.98 *** 2.750 1.94 *

t-test

CONS_QSPE = CONS_VIE -1.685 -1.01

FE Quarter Quarter Quarter Quarter & Year

# of Obs. 188 188 188 402 Adj. Rsq. 0.8052 0.8119 0.8089 0.6580

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