Wealth effects from asset securitization (the case of Australia) Authors: Nicha Lapanan Stefan Anchev Supervisor: Anders Isaksson Student Umeå School of Business Autumn semester 2011 Master thesis, two year, 30 hp Acknowledgement First of all, we want to express our gratitude to our parents and friends. Without their full support and encouragement, we would never be able to complete this Master program. Furthermore, we would like to thank our supervisor, Anders Isaksson, who was guiding us through the writing process and who showed deep understanding for our situation. We would also like to thank Mr. Matias Lampe. The phone conversation with Mr. Lampe made us realize that this study could not be conducted with data from Sweden. He saved us a lot of time and helped us focus our attention someplace else. ………………………... …………………...…… Nicha Lapanan Stefan Anchev Umeå, September 2011 I About the authors: Nicha Lapanan Nicha has Bachelor degree in Business administration, major in accounting from Thammasat University, Thailand. After graduation, Nicha was working for 1 year at “KPMG”, as an assistant auditor. Currently, she is pursuing Master degree in Finance at Umeå School of Business and Economics, Umeå University. Additionally, she is enrolled in the Chartered Financial Analyst (CFA) and Financial Risk Management (FRM) program. Contact info: [email protected] Stefan Anchev Stefan graduated from the Faculty of Business administration at the South East European University, Republic of Macedonia. His major was finance and accounting. After finishing his studies, Stefan was working as an assistant auditor at “Dimitrov Revizija DOO”. Since 2009, Stefan is enrolled in the Master in Finance program at Umeå School of Business and Economics, Umeå University. Stefan is currently undertaking the Chartered Financial Analyst (CFA) program. Contact info: [email protected] II Abstract Asset securitization is one of the most important financial innovations recently. With an impressive growth in terms of volume of issuance, from almost zero to five trillion USD, in a period of 15-20 years, it is one of the most rapidly growing markets in the financial world. Yet, little is known about this, literally invisible market. Companies engage in asset securitization for a variety of reasons and numerous advantages and disadvantages of asset securitization can be found throughout the literature. Asset securitization has an impact on a number of stakeholder groups: shareholders, managers, employees, investors, the financial markets and ultimately the overall economy and society. Asset securitization is one of the reasons for the financial crisis that started in mid 2007. Since the recent financial turmoil, it became clear the asset securitization was the primary funding source for companies in the financial industry and it was the primary supplier of credit in developed economies. Because of its importance and impact, it is very important that we study the reasons, the motivations, the consequences and the effects from this so powerful financial innovation. And it is important to study it from as many different aspects as possible. Many questions surrounding asset securitization are unanswered and it is important to answer them sooner. This study investigates the wealth effects from asset securitization on the shareholders of the securitizing companies. We study whether the announcement about a pending securitization transaction has any impact on the stock price of the securitizing company. That way we can discover whether asset securitization creates wealth, destroys wealth or has no impact on wealth at all. Not many studies have been done on this topic so far. The existing seven studies are focused mainly on the US and the EU market and report contradicting results. In this study, for the first time, data from Australia is being used. The Australian securitization market is the second, single most active securitization market in the world, after the US market. We conduct quantitative analysis on a sample of 98 securitization transactions during the period 2000-2006. With this sample, we cover almost 29% of the number of securitization transactions during that period and almost 39% in terms of volume of issuance. To analyze the data we use standard event study methodology, common for this type of studies. Our analysis reveals that investors in Australia do not perceive asset securitization favorably. Securitizing companies’ stock price decreases in the 10 days around the securitization announcement day, resulting in statistically significant wealth losses for the originating companies’ shareholders. Furthermore, the wealth losses are significant for less frequent securitizers, for securitizers that engage in small volume securitization transactions and for securitizing companies with low asset quality. With this study we make theoretical and practical contribution. We lend empirical support to the previous theories and we help managers, shareholders and investors shape their forecasts. Keywords: asset securitization, wealth effects, stock price, shareholders, originating company, securitization announcement, event, asset-backed securities. III Table of contents: Page Acknowledgement ……………………………………………………………………. I About the authors…………………………………………………………………….. II Abstract………………………………………………………………………………. III Table of contents……………………………………………………………………... IV List of figures………………………………………………………………………… VI List of tables………………………………………………………………………….. VI Appendix list…………………………………………………………………………. VI Chapter 1: Introduction……………………………………………………………. 1 1.1. Problem background…………………………………………………………….. 1 1.2. Choice of topic…………………………...……………………………………… 5 1.3. Research gap………………………………...…………………………………... 6 1.4. Research question and research objective……...………………………………... 8 1.5. Contribution of the study………………………...……………………………… 8 1.6. Structure of the thesis……………………………...…………………………….. 10 Chapter 2: Asset securitization…………………………………………………….. 11 2.1. The process of asset securitization………….…………………………………… 11 2.2. Assets eligible for asset securitization….……………………………………….. 15 2.3. Asset-backed securities (ABS)…………………………...……………………… 15 2.4. Credit enhancement……………………………………………………………… 18 2.5. Advantages of asset securitization for originating companies…………………... 20 2.6. Disadvantages of asset securitization for originating companies……………….. 23 Chapter 3: The Australian securitization market…..……………….……………. 25 3.1. Characteristics of the Australian securitization market…………...…………….. 25 3.2. Overview of the regulatory environment for asset securitization in Australia….. 29 3.3. Restarting the Australian securitization market – actions and proposals…...…… 31 3.3.1. Government guaranteed residential mortgage-backed securities……………… 32 3.3.2. Government purchase of assets in the secondary market……………………… 32 3.3.3. Government liquidity scheme…………………………………………………. 32 3.3.4. Modifications of the AOFM securitization program………………………….. 33 3.3.5. Proposals by the Reserve Bank of Australia…………………………………... 33 Chapter 4: Previous studies and hypotheses development………………..……… 34 4.1. Larry J. Lockwood, Ronald C. Rutherford and Martin J. Herrera (1996)...…….. 34 4.2. Hugh Thomas (1999)……………………………………………………………. 36 4.3. Hugh Thomas (2001)……………………………………………………………. 37 4.4. Dominic Gasbarro, Mark Stevenson, Robert G. Schwebach and J. Kenton Zumwalt (2005)………………………………………………………………………. 39 4.5. Gunter Franke and Pieter Krahnen (2006)........................................................... 41 4.6. Chang Liu (2007)………………………………………………………………... 42 4.7. Christian Farruggio, Tobias C. Michalak and Andre Uhde (2010)…………….... 43 4.8. Hypotheses development………………………………………………………... 44 IV Chapter 5: Research methodology, data and statistical method………………… 49 5.1. Research methodology………………………………………………………….. 49 5.1.1. Research philosophy…………………………………………………………... 49 5.1.2. Research approach……….……………………………………………………. 51 5.1.3. Research strategy……….……………………………………………………... 52 5.2. Data and sample construction…………………………………………………… 53 5.2.1. Data collection process………………………………………………………... 53 5.2.2. Primary data and sources……………………………………………………… 54 5.2.3. Secondary data and sources…………………………………………………… 55 5.2.4. Criticism of data quality……………………………………………………….. 55 5.2.5. Sample selection criteria...………………………………………………….…. 55 5.3. Statistical method – event study methodology………………………………….. 57 5.3.1. Event definition………………………………………………………………... 58 5.3.2. Establishing the estimation period and the event period………………………. 58 5.3.3. Measuring actual daily returns………………………………………………… 59 5.3.4. Measuring normal (expected) daily returns…………………………………… 60 5.3.5. Measuring abnormal daily returns…………………………………………….. 60 5.3.6. Measuring average abnormal returns (AAR)………………………………….. 62 5.3.7. Measuring cumulative average abnormal returns (CAAR)…………………… 62 5.3.8. Significance tests and interpretation of findings………………………………. 63 5.3.9. Sample partitioning……………………………………………………………. 64 5.3.10. Criticism of practical research method………………………………………. 64 5.4. Research quality criteria…………………………………………………………. 65 5.4.1. Internal validity………………………………………………………………... 65 5.4.2. Construct validity……………………………………………………………… 65 5.4.3. External validity……………………………………………………………….. 65 5.4.4. Reliability……………………………………………………………………… 66 Chapter 6: Analysis…………….…………………………………………………… 67 6.1. Descriptive statistics……………………………………………………………... 67 6.2. Analysis………………………………………………………………………….. 71 6.2.1. Controlling for securitization frequency………………………………………. 73 6.2.2. Controlling