Cem Demiroglu

How Important is Having Skin in the Game? Originator-Sponsor Affiliation and Losses on Mortgage-Backed Securities

This article examines the relationship between a mortgage originators affiliation with the sponsor of a securitization or the servicer of the securitized loans and the default rate on the securitized mortgages. We find that default rates are significantly lower for securitizations in which the originator is affiliated with the sponsor or servicer. Consistent with investors expecting performance to vary with affiliation, we find that the initial yields on mortgage-backed securities (MBS) are lower and the percentage of AAA-rated securities issued against the securitized pool of loans is higher when the originator is affiliated with either the sponsor or servicer. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

The Use of Bank Lines of Credit in Corporate Liquidity Management: A Review of Empirical Evidence

This paper reviews empirical evidence on the use of bank lines of credit as a source of corporate liquidity. Traditional explanation for lines of credit is that they provide insurance against liquidity shocks, in much the same as way hoarding cash does. However, recent empirical research suggests that access to lines of credit is contingent on the credit quality of the borrower as well as the financial condition of the lender. These findings suggest that lines of credit are an imperfect substitute for cash as a source of corporate liquidity.

Works of Friction? Originator-Sponsor Affiliation and Losses on Mortgage-Backed Securities

This paper examines how originator risk retention is related to the structure, pricing, and performance of securitized pools of residential mortgages created during the 2003-2007 period. We argue that originator risk retention is likely to vary positively with originator-sponsor and originator-servicer affiliation. We refer to the lack of affiliation as measures of distance-from-loss. Overall, we find that, after controlling for borrower and deal characteristics, cumulative net loss and foreclosure rates are significantly higher for mortgage-backed securities (MBS) in which originators are not affiliated with the sponsor or servicer (i.e., the loss distance is greater). We also find that the losses and foreclosures occur earlier in MBS with greater distance-from-loss. Consistent with screening being more important for loans with limited or no documentation (low-doc) than full documentation loans, we find that affiliation is related to loan performance only in the case of low-doc loans. Moreover, we find that the distance was also related to losses before the peak of the housing market. Consistent with investors recognizing the potential loss exposure from greater distance-from-loss, we find that the average yield spreads are higher on MBS with greater distance. Consistent with the performance results, we find a positive relation between yields and distance from loss only for deals that consist primarily of low-doc loans. We also find that the percentage of AAA-rated securities issued against the mortgage pool is decreasing in the distance. Finally, deals with greater distance are significantly more likely to employ overcollateralization accounts (that require the sponsor to have greater skin in the game). These results suggest that, while ex post investors might have misestimated their exposure to losses arising from incentive conflicts with the originator, ex ante frictions were reflected (at least in part) in the pricing and the structure of MBS.

Indicators of Collateral Misreporting

Recent studies use retrospective automated valuation models (AVMs) to investigate whether appraisals of collateral values associated with securitized residential mortgage loans were systematically inflated during the recent housing boom. In this paper, we provide evidence that high AVM pricing errors as well as selection bias in samples of completed loans, which are conditioned on relatively high appraisals, may generate the appearance of appraisal bias even when the original appraisals are unbiased estimates of the underlying value of the collateral. We present evidence that the estimated frequency of appraisal overstatement is quite sensitive to assumptions concerning loan denial rates as well as the magnitude of and the correlation between AVM and original appraisal pricing errors.

Does Religion Affect Economic Decisions? Evidence from Ramadan Loans

We examine the effects of nutrition and spiritual sentiment on economic decision-making in the context of Ramadan, an entire lunar month of daily fasting from dawn to sunset and increased spiritual reflection in the Muslim faith. Using an administrative data set of all bank loans originated in Turkey during 2003-2013, we find that small business loans originated during Ramadan are about 10 to 15 percent more likely to become delinquent within two years of origination than loans originated outside of Ramadan. Despite their worse performance, Ramadan loans have lower credit spreads than non-Ramadan loans at origination. Consistent with Ramadan-induced judgment errors committed by individual loan officers, we find no relation between origination in Ramadan and the performance of personal loans which are mostly automated, and large business loans where approval decisions are made by credit committees. Loans granted by banks whose loan officers are more likely to observe the Ramadan perform worse, and so do loans originated on hot Ramadan days when adverse physiological effects of fasting are greatest, and loans that resemble charitable lending involving financially strong lenders. Our identification strategy addresses alternative explanations including seasonality and changing borrower and loan characteristics during Ramadan.

The Relevance of Credit Ratings in Transparent Bond Markets

We find that mandated public dissemination of over-the-counter transactions in corporate debt securities via the TRACE system dramatically reduces the average short-term market reaction to rating downgrades by both issuer-paid and investor-paid rating agencies. The effect of dissemination is greatest where there is greater uncertainty about credit risk. After dissemination, ratings become more accurate predictors of default and more sensitive to innovations in credit spreads. Both before and after dissemination, ratings provide no incremental credit risk information relative to credit spreads. These results suggest that the dissemination of over-the-counter trades fills information gaps and reduces reliance on credit ratings.

Do Market Prices Improve the Accuracy of Court Valuations in Chapter 11

This paper shows that public dissemination of trading information for registered corporate bonds reduces valuation errors in Chapter 11 bankruptcy reorganizations by about half, virtually eliminating unintended wealth transfers between claimants and consequent violations of the absolute priority rule. The impact of dissemination is significantly greater where alternative market-based indicators of firm valuation, such as analyst estimates or outside bids for the companys assets are lacking, and significantly lower where hedge funds are among the debtor’s largest unsecured claimants. The results suggest that the transparency of market prices helps improve the distributional efficiency of Chapter 11 bankruptcy and provide support for proposals to increase the availability of market-based signals to aid the valuation process.

Ratings Quality and Borrowing Choice

This paper examines how the quality of issuer-paid credit ratings affects the choice between “arm’s length” vs. intermediated (e.g., bank) debt. We argue that investors are more likely to question the quality of issuer-paid ratings when those ratings are more favorable than investor-paid ratings or market-based indicators of credit quality (e.g., credit default swap (CDS) spreads). Concerns about the quality of issuer-paid ratings, in turn, increase information asymmetries between issuers and investors, resulting in a higher cost of funding. Consistent with this argument, we find that bond spreads are inversely related to our measures of rating quality, with rating quality having the greatest impact on bonds where the incentives to inflate ratings are the greatest. We also find that firms with poor quality ratings substitute bank loans and private debt for public debt. Using a difference in differences analysis, we find that bank borrowing leads to a significant reduction in the bond premium of firms with poor quality ratings. Overall, our results suggest that poor quality issuer-paid credit ratings are associated with a “lemons discount” that debt issuers attempt to avoid by borrowing from better-informed private lenders.