Asset Sales, Recourse, and Investor Reactions to Initial Securitizations: Evidence Why Off-balance Sheet Accounting Treatment Does not Remove On-balance Sheet Financial Risk

Abstract

Both accounting and regulatory treatments classify securitizations as a “sale” of assets, therefore allowing the issuer to remove the assets from their books. This “off-balance sheet” treatment relies crucially on the concept of “true” sale. The concept most diametrically opposed from a true sale is a “financing.” In a financing, assets do not leave the firm’s books, so the transaction is exclusively “on-balance sheet.” The present paper presents conjectural evidence of recourse activity and bankruptcy seizure that undermine the fundamental concept of true sale. The paper then analyzes investor reactions to firms’ first securitization announcements, demonstrating negative short-term equity returns and negative long-term operating performance following initial securitizations. Such reactions constitute evidence that securitizations are more similar to financings than asset sales. Additional analysis shows that securitization is also associated with increased systematic risk, suggesting that the rapid growth fueled by securitization is similar to increasing leverage. The effect is more pronounced for banks than non-banks, suggesting that there is substantial value to regulatory capital arbitrage in addition to accounting arbitrage.