Securitization,risk-transferring and financial instability: The case of Spain

The 2007–2010 financial crisis has hit a variety of countries asymmetrically. The case of Spain is particularly illustrative as it exemplifies in a vivid manner most of the core issues largely responsible for the crisis. This country experienced a pronounced housing bubble partly funded via spectacular developments in its securitization markets leading to looser credit standards and subsequent financial stability problems. We analyze the sequential deterioration of credit in Spain considering rating changes in securitized deals. Using a sample of 20,286 observations on securities and rating changes from 2000Q1 to 2010Q1 we build a model in which loan growth, on balance-sheet credit quality and rating changes are estimated simultaneously. Our results suggest that loan growth significantly affects on balance-sheet loan performance with a lag of at least two years. Additionally, loan performance is found to explain rating changes with a lag of four quarters. Importantly, bank characteristics (in particular, observed solvency, cash-flow generation and cost efficiency) also affect ratings considerably. Additionally, these other bank characteristics seem to a higher weight in the rating changes of securities issued by savings banks as compared with commercial banks.     

Incorporating risk input into the analysis of bank productivity: Application to the Taiwanese banking industry

This study reappraises banks’ productivity by using 42 Taiwanese banks during 1999–2007 as observations. It introduces an input-oriented generalized metafrontier Malmquist productivity index (I-gMMPI), while considering the latent effect of risk-taking behavior in the analytic framework. We learn that public and private banks should face separate short-term technological frontiers, while the econometric model considering risk input can portray banks’ operating frontiers better. Moreover, neglecting the influence of risk input would bring about distortions of efficiency, technology and TFP dynamic estimations for banks; meanwhile, the degree of scale economies would also be overestimated. The paper concludes that neglecting the risk-taking essence in bank performance evaluation is equal to allowing banks to barter risk-bearing as the term for further output growth. Consequently, the potential cost is that banks may excessively aggrandize their scales of business, implying the possibility of another financial crisis.     

Conflicts of interest in sell-side research and the moderating role of institutional investors

Because sell-side analysts are dependent on institutional investors for performance ratings and trading commissions, we argue that analysts are less likely to succumb to investment banking or brokerage pressure in stocks highly visible to institutional investors. Examining a comprehensive sample of analyst recommendations over the 1994–2000 period, we find that analysts’ recommendations relative to consensus are positively associated with investment banking relationships and brokerage pressure but negatively associated with the presence of institutional investor owners. The presence of institutional investors is also associated with more accurate earnings forecasts and more timely re-ratings following severe share price falls.     

The role of co-managers in reducing flotation costs: Evidence from seasoned equity offerings

We examine the effect on expected flotation costs of including co-managers in the underwriting syndicate. We consider five components of SEO flotation costs: announcement returns, underpricing, the probability of withdrawals, offering delays, and underwriting spreads. The results show that the characteristics of co-managers participating in syndicates have significant effects on flotation costs, while the effect of the number of co-managers is largely insignificant. Our results are consistent with the notion that highly reputable underwriters and commercial banks serving as co-managers serve a certification role, reducing information asymmetries and, as a result, lowering SEO flotation costs.     

A study on long-run inefficiency levels of a panel dynamic cost frontier under the framework of forward-looking rational expectations

This paper aims to provide a theoretical underpinning of the dynamic efficiency model pioneered by [Ahn, S.C., Good, D.H., Sickles, R.C., 2000. Estimation of long-run inefficiency levels: A dynamic frontier approach. Econometric Reviews 19, 461–492]. In the context of a quadratic loss function this paper formulates a multi-period forward-looking rational expectations model on the evolution of the technical inefficiency level, which correctly produces a dynamic panel data model. The model is illustrated using panel data of 112 French banks. Encouraging evidence of superiority in favor of the model is reached. Substantial cost inefficiency prevails in this industry, where the constituent banks are characterized as having volatile adjustment speeds toward their long-run steady states. The sample banks exhibit increasing returns to scale and product-mix economies.     

The economics of conflicts of interest in financial institutions

A conflict of interest exists when a party to a transaction can gain by taking actions that are detrimental to its counterparty. This paper examines the growing empirical literature on the economics of conflicts of interest in financial institutions. Economic analysis shows that, although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts. The empirical literature reaches conclusions that differ across types of conflicts of interest but are overall more ambivalent and certainly more benign than the conclusions drawn by journalists and politicians from mostly anecdotal evidence.     

The impact of securitization on the expansion of subprime credit

This paper investigates the relationship between securitization activity and the extension of subprime credit. The analysis is motivated by two sets of compelling empirical facts. First, the origination of subprime mortgages exploded between the years 2003 and 2005. Second, the securitization of subprime loans increased substantially over the same time period, driven primarily by the five largest independent broker/dealer investment banks. We argue that the relative shift in the securitization activity of investment banks was driven by forces exogenous to factors impacting lending decisions in the primary mortgage market and resulted in lower ZIP code denial rates, higher subprime origination rates, and higher subsequent default rates. Consistent with recent findings in the literature, we provide evidence that the increased securitization activity of investment banks reduced lenders' incentives to carefully screen borrowers.     

Do interbank customer relationships exist? And how did they function in the crisis? Learning from Italy

Using 11 years of monthly Italian bank-by-bank data, this paper correlates the bilateral amounts and the identity of each interbank borrower and lender with a long list of explanatory variables. The results show that interbank customer relationships, i.e. stable and strong relationships between pairs of borrowing and lending banks, do exist in Italy, that they persist over time, and that they functioned well during the crisis, enabling the healthier banks to provide and the troubled ones to receive funds.     

So what do I get? The bank's view of lending relationships

While many empirical studies document borrower benefits of lending relationships, less is known about lender benefits. A relationship lender's informational advantage over a non-relationship lender may generate a higher probability of selling information-sensitive products to its borrowers. Our results show that the probability of a relationship lender providing a future loan is 42%, while for a non-relationship lender, this probability is 3%. Consistent with theory, we find that borrowers with greater information asymmetries are significantly likely to obtain future loans from their relationship lenders. Relationship lenders are likely to be chosen to provide debt/equity underwriting services, but this effect is economically small.     

The price-setting behavior of banks: An analysis of open-end leverage certificates on the German market

This paper presents the first analysis of open-end leverage certificates on the German market. The major innovations of these certificates are twofold. First, issuers announce a price-setting formula according to which they are willing to buy and sell the certificates over time. Second, the product’s lifetime is potentially endless. Our main findings are that the price-setting formula is (i) designed to strongly favor the issuer and (ii) is consistent with the main outcome of the ‘life cycle hypothesis’ for structured financial products [Stoimenov, P.A., Wilkens, S., 2005. Are structured products ‘fairly’ priced? An analysis of the German market for equity-linked instruments. Journal of Banking and Finance 29, 2971–2993]. (iii) This holds for different product features and also in the presence of issuers’ credit risk and jump risk in the underlying.     

Securitization and systematic risk in European banking: Empirical evidence

Using a unique dataset of 592 cash and synthetic securitizations issued by 54 banks from the EU-15 plus Switzerland over the period from 1997 to 2007 this paper provides empirical evidence that credit risk securitization has a positive impact on the increase of European banks’ systematic risk. Baseline results hold when comparing estimated beta coefficients with a control group of similar non-securitizing banks. Building several sub-samples we additionally find that (a) the increase in systematic risk is more relevant for larger banks that repeatedly engage in securitization, (b) securitization is more important for small and medium financial institutions, (c) banks have a higher incentive to retain the larger part of credit risk as a quality signal at the beginning of the securitization business in Europe, and (d) the overall risk-shifting effect due to securitization is more distinct when the pre-event systematic risk is low.     

The anatomy of bank diversification

We use panel data from nine countries over the period 1996–2008 to test how revenue diversification affects bank value. Relying on a comprehensive framework for bank performance measurement, we find robust evidence against a conglomerate discount, unlike studies concerned with industrial firms. Rather, diversification increases bank profitability and, as a consequence also market valuations. This indirect performance effect does not depend on whether diversification was achieved through organic growth or through M&A activity. We further demonstrate that previous results in the literature on the impact of diversification on bank value presumably differ due to the way diversification is measured, and the negligence of the indirect value effect via bank profitability. Our evidence against a conglomerate discount in banking remains robust also during the sub-prime crisis.     

The causes and consequences of venture capital stage financing

This paper examines the causes and consequences of venture capital (VC) stage financing. Using information about the physical location of an entrepreneurial firm and the geographic distance between the VC investor and the firm, I show that VC investors located farther away from an entrepreneurial firm tend to finance the firm using a larger number of financing rounds, shorter durations between successive rounds, and investing a smaller amount in each round. However, VC investors' propensity to stage is independent of whether the firm is located in a close-knit community. I also find that VC staging positively affects the entrepreneurial firm's propensity to go public, operating performance in the initial public offering (IPO) year, and post-IPO survival rate, but only if the firm is located far away from the VC investor. However, the effect of VC staging on entrepreneurial firm's performance is independent of whether it is located in a close-knit community. The findings are robust to a variety of alternative proximity measures, instrumental variables, and econometric approaches for dealing with endogeneity problems.     

The role of private equity group reputation in LBO financing

This paper investigates whether the reputation of acquiring private equity groups (PEGs) is related to the financing structure of leveraged buyouts (LBOs). Using a sample of 180 public-to-private LBOs in the US between January 1, 1997 and August 15, 2007, we find that reputable PEGs are more active in the LBO market when credit risk spreads are low and lending standards in the credit markets are lax. We also find that reputable PEGs pay narrower bank and institutional loan spreads, have longer loan maturities, and rely more on institutional loans. In addition, while we find that PEG reputation is positively related to buyout leverage (i.e., LBO debt divided by pre-LBO earnings before interest, taxes, and amortization (EBITDA) of the target), and leverage is significantly positively related to buyout pricing, we do not find any direct relation between PEG reputation and buyout valuations. The evidence suggests that PEG reputation is related to LBO financing structure not only because reputable PEGs are more likely to take advantage of market timing in credit markets and but also because PEG reputation reduces agency costs of LBO debt.     

The contribution of product mix versus efficiency and technical change in US banking

Similar to a Du Pont analysis, this paper divides the changes in returns on assets of US commercial banks for the period from 2000 to 2005 into conventional measures of bank performance. The contribution of product mix is significant and offsets losses from technical change and operating efficiency. Banks respond to changes in the business environment by switching towards more lucrative traditional and nontraditional products. Large banks are found to benefit more than community banks from the switch to an optimal output portfolio mix including new products spawned by recent financial innovations and deregulation.     

Great expectations: Banks as equity underwriters

We examine the in-roads commercial banks have made into equity underwriting over 1990–2002. While banks end the period handling upwards of 25% of equity underwriting, this increase results almost exclusively from acquisitions of investment banks with an already established market share of equity underwriting. We find a significant decline in the market share of equity underwriting that banks acquired in the post-merger period, a decline that is larger than that experienced by independent investment banks of comparable reputation. Banks lose market share because they originate fewer IPOs and their IPOs have a lower incidence of follow-on SEOs compared to independent investment banks. Following the merger, banks experience a large fall off in their ability to retain follow-on SEOs and are less successful in winning SEO mandates when an issuer switches from its IPO underwriter. Overall, the findings suggest it has been difficult for banks to achieve scope economies in equity underwriting.     

Entrepreneurial finance: Banks versus venture capital

We analyze how entrepreneurial firms choose between two funding institution: banks, which monitor less intensively and face liquidity demands from their own investors, and venture capitalists, who can monitor more intensively but face a higher cost of capital because of the liquidity constraints that they impose on their own investors. Because the firm's manager prefers continuing the firm over liquidating it and aggressive (risky) continuation strategies over conservative (safe) continuation strategies, the institution must monitor the firm and exercise some control over its decisions. Bank finance takes the form of debt, whereas venture capital finance often resembles convertible debt. Venture capital finance is optimal only when the aggressive continuation strategy is not too profitable, ex ante; the uncertainty associated with the risky continuation strategy (strategic uncertainty) is high; and the firm's cash flow distribution is highly risky and positively skewed, with low probability of success, low liquidation value, and high returns if successful. A decrease in venture capitalists’ cost of capital encourages firms to switch from safe strategies and bank finance to riskier strategies and venture capital finance, increasing the average risk of firms in the economy.     

Efficiency and risk in European banking

We assess the inter-temporal relationship between bank efficiency, capital and risk in a sample of European commercial banks employing several definitions of efficiency, risk and capital and using the Granger-causality methodology in a panel data framework. Our results suggest that lower bank efficiency with respect to costs and revenues Granger-causes higher bank risk and that increases in bank capital precede cost efficiency improvements. We also find that more efficient banks eventually become better capitalized and that higher capital levels tend to have a positive effect on efficiency levels. These results are generally confirmed by a series of robustness tests. The results have potentially important implications for bank prudential supervision and underline the importance of attaining long-term efficiency gains to support financial stability objectives.     

The determinants of shareholder value in European banking

This paper examines the determinants of shareholder value creation for a large sample of European banks between 1998 and 2005. As the recent turmoil in global banking systems has illustrated, bank performance can have a substantial influence on efficient capital allocation, company growth and economic development. We use a dynamic panel data model where the bank’s shareholder value is a linear function of various bank-specific, industry-specific and macroeconomic variables. We show that shareholder value has a positive relationship with cost efficiency changes, while economic profits are linked to revenue efficiency changes. Credit losses, market and liquidity risk and leverage are also found to substantially influence bank performance. These results are robust to a variety of different model specifications.     

On the Riskiness of Universal Banking: Evidence from Banks in the Investment Banking Business Pre- and Post-GLBA

We explore whether an economically significant differential exists in market-based risk measures between universal banks and traditional banks. Using a three-asset portfolio regression model, we find that between 1990 and 2007—a period of gradual deregulation culminating in passage of the Gramm–Leach–Bliley Act (GLBA) of 1999—an increased participation in investment banking was associated with higher total and unsystematic risks and no significant change in systematic risk. Small risk-reduction benefits emerged in the post-GLBA era, but such benefits were likely the result of the particular sample period rather than a fundamental change in bank structure following the GLBA. Our results cannot justify the GLBA on risk-reduction grounds, though the Act may be defensible for other reasons.