Asset-Backed Securities: Costs and Benefits of "Bankruptcy
Asset-Backed Securities: Costs and Benefits of “Bankruptcy Remoteness”∗ Kenneth M. Ayotte† Stav Gaon‡ Columbia Business School Columbia Business School Abstract This paper focuses on a key property of asset-backed securities (ABS); namely, that ABS are designed to achieve “bankruptcy remoteness” of the securitized assets from the borrowing firm. This provides lenders with maximal protection from dilution in bankruptcy that is not available with other contracts, such as secured debt. ABS can have real effects in allowing firmstocommittomoreefficient investment decisions in bankruptcy. We show that securitization of replaceable assets, such as accounts receivable, prevents inefficient continuation in bankruptcy, but securitization of neces- sary assets can lead to inefficient liquidations. In these circumstances, secured debt and/or leases can be preferred. We provide empirical support for the importance of bankruptcy remoteness in ABS contracts using a controversial decision in the Chapter 11 bankruptcy of LTV Steel, in which a securitization contract was unexpectedly treated as a secured loan. Using adifference-in-differences approach, we find that ABS spreads for securitizers eligible for Chapter 11 increased significantly more than spreads for insured bank securitiz- ers, who are not Chapter 11-eligible, in the period following the LTV filing. The results demonstrate that the creditor protection provided by “bankruptcy remoteness” is indeed valuable and priced in financial markets. ∗We would like to thank Barry Adler, Sugato Bhattacharyya, Jean Boivin, Patrick Bolton, Margarida Catalao, Frank Edwards, Chris Mayer, Rick Mishkin, Ed Morrison, Francisco Perez-Gonzalez, Robert Ras- mussen, Suresh Sundaresan, Walter Torous, Laurent Vilanova, and seminar participants at the ESSFM Gerzensee, the Texas Finance Festival, Wharton Bankruptcy/Financial Distress Conference, Columbia Con- ference for Bankruptcy Judges, and Conference on Financial Innovation for thoughtful comments and sug- gestions.
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