Securitization Economics by Laurent Gauthier

Author:Laurent Gauthier
Language: eng
Format: epub
ISBN: 9783030503260
Publisher: Springer International Publishing

Fig. 5.8US agency and non-agency historical securitization issuance share ($bb).

Source SIFMA Statistics and author’s own calculations

While the evolution in securitization channel may explain the similar increasing trend in R-squares between agencies and subprime, it does not account for the generally low level of R-squares. It simply appears as though the pricing of risk was less a function of hard characteristics in the agency market.

Another angle through which we can shed light on these patterns is to consider structure execution. As we will discuss in Chap. 6, and as we have alluded to in the discussion of security design in Chap. 4, a high coupon rate can be efficiently used for credit enhancement through the technique of excess-spread. In the subprime market, the coupon must be commensurate with the credit enhancement requirements set by the rating agencies, themselves a function of the loans’ hard characteristics. In the agency market, on the other hand, once a loan has received a wrap, its valuation will depend on the market’s assessment of its negative convexity. A subprime-like loan with a high coupon but with an agency wrap would have to trade at a very high price, because of the high coupon, compounded by the lower refinancing sensitivity brought about by its low credit quality. Hence, it is unlikely this would be fairly priced by the market. In other words, even if loan coupons were mostly randomly set as a function of their characteristics (or mostly driven by local competition and soft information as well), then the ones that would end up being securitized as non-agencies and subprime, in particular, would have to observe that coupon/risk relationship, while this would not be such a factor for agency securitizations. As a result, the trend in the coupon/risk relationship in the subprime market could be due to an increase in the attention paid to the efficiency of structuring in private-label deals, while at the same time a less strong relationship would be observed in the agency market. Note that it is possible that the subprime market would have been particular in that respect due to the fact that agency wraps on these loans would have been essentially prohibitive.

Having shown how securitization lead to the production of lower quality loans, we now examine a related issue, which is whether, given a set of loans on balance sheet, issuers would have picked the worst ones for securitization. We are not considering the way in which the loans are made anymore, only how they are selected.

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