securitization of subprime mortgages an empirical analysis of the loan sale decisions of depository...

Securitization of Subprime Mortgages

An Empirical Analysis of the Loan Sale Decisions of Depository Institutions

Paul Calem and Jonathan Liles

Freddie Mac

and

Christopher Henderson

Federal Reserve Bank of Philadelphia

August 20, 2008

The views expressed are those of the authors and do not represent official views of Freddie Mac, the Federal Reserve Bank of Philadelphia, or the Federal Reserve System


Banks have an incentive to securitize loans to reduce regulatory capital requirements, diversify funding sources, and limit concentrations of risk in the asset portfolioo The prevailing view is that regulatory capital requirements are too

high for most mortgage loans, giving financial institutions incentive to sell less risky loans to investors

However, agency problems may impede the functioning of securitization marketso Lenders may have private information enabling them to sell riskier

loans into public markets


This classic “lemons problem” may have been a factor affecting subprime (ABS) securitizationo The lemons problem, exacerbated by overly optimistic

assessments by investors of the outlook for house prices and of credit risk, likely contributed to the recent subprime market collapse

o It may be a key factor influencing the extent and form of future recovery of the subprime market

o Such problems are mitigated in the prime (MBS) market due to:o Standardized products

o Lower risk, less heterogeneous borrowers

Research Objectives

Explore the decision of depository institutions to sell or retain subprime mortgages during 2004-2006o Use HMDA data merged with data from LoanPerformance on

characteristics of the subprime market at the neighborhood (ZIP code) level

Seek evidence on the extent to which regulatory arbitrage was a driver of subprime mortgage securitizationo Did banking institutions tend to sell higher-yield subprime mortgages,

contrary to the conventional view?

Seek evidence on “euphoria” in the ABS market fueled by rapid house price appreciation in 2005 and 2006o Did loan sale behavior change?

Research Objectives

Seek evidence on information asymmetries in the subprime securitization marketo Did banks sell higher risk subprime mortgages without fully

signaling increased risk through higher asset yields?

Explore the dimensions along which securitization transactions costs varyo Are certain loan categories or types of institutions associated with

greater likelihood of loan sale?

Preview of Findings

During 2004, banks were less likely to sell the higher risk subprime loans they originated (those with larger APR spread), consistent with regulatory capital arbitrage

Subsequently, we observe a reversal of this relationship, consistent with euphoria-driven undervaluing of credit risk in ABS markets

We obtain evidence suggestive of informational advantages of depository institutionso For example, banks were more likely to sell loans associated with

neighborhoods with high future default rates

Preview of Findings

Loan categories associated with higher transactions costs, such as very small loan sizes, exhibit reduced likelihood of loan sale

HOEPA loans were comparatively likely to be retained

Relevant Prior Literature

Securitization and Agency Problemso Akerlof (1970)

o Hill (1996)

o Demarzo and Duffie (1999)

o DeMarzo (2005)

Loan Saleso Samolyk (1989)

o Drucker and Puri (2007)


Regulatory Capital Arbitrage and Mortgage Securitizationo Picker (1996)o Jones (2000)o Calem and LaCour-Little (2004)o Ambrose, LaCour-Little, and Sanders (2004)o Calem and Follain (2007)

Subprime Mortgage Lending: Generalo Apgar and Herbert (2006)o Avery, Brevoort, and Canner (2006)o Chomsisengphet and Pennington-Cross (2006)o Smith (2007)


Recent Developments in the Subprime Mortgage Marketo DiMartino and Duca (2007)

o Doms, Furlong, and Krainer (2007)

o Edmiston and Zalneraitis (2007)

o Federal Reserve Bank of San Francisco (2007)

o Gerardi, Shapiro, and Willen (2007)

o President’s Working Group on Financial Markets (2008)


Subprime Mortgage Lending: Agency and Information Problemso Alexander, Grimshaw, McQueen, and Slade (2002)o Courchane, Surette, and Zorn (2004)o Crews-Cutts and Van Order (2005)o An and Bostic (2006)o Golding, Green, and McManus (2008)

Securitization of Subprime Mortgageso DiMartino, Duca, and Rosenblum (2007)o Ashcraft and Schuermann (2008)o Keys, Mukherjee, Seru, and Vig (2008)o Mian and Sufi (2008)

Economic Factors Influencing the Loan Sale/Securitization Decision

Regulatory capital Funding and liquidity Informational advantages of depository institutions Transactions costs Risk diversification Predatory lending risk

Regulatory Capital Arbitrage

Required regulatory capital exceeds economic capital for the credit risk of prime mortgages

This creates an incentive to retain higher risk, subprime mortgages

o Regulatory supervision may bring some restraint to this incentive

Funding and Liquidity

A liquid securities market is a dependable source of funds for loan originations

Euphoria among investors may bring “too much” liquidity into the market o Particular risks may be unrecognized or undervalued by the

market, generating increased loan sales by banks

o Euphoria fueled by rapid house price acceleration may have contributed to growth in subprime mortgage securitization during 2005-2006

Informational Advantages of Depository Institutions

Ties to local markets and relationships with borrowerso Community banks are attentive to neighborhood conditions that

could influence mortgage credit risk

o Even large, centralized organizations may develop such tieso They monitor the profitability of branch networks and correspondent

relationships

o They engage in community reinvestment activities

More efficient use of information that is potentially also available to the securities marketo Banks may incorporate more local and regional economic data into

their decision processes than aggregators/asset managers/investors

Informational Advantages of Depository Institutions

Superior controls around information processes due to better aligned incentives and regulatory supervisiono Model risk and other operational risks may receive greater

attention from banks

o Banks may more consistently apply overrides to models in fast-growing segments for which the models may not be representative

o Hybrid ARM loans with initial, “teaser” margins

o Non-traditional products

o Loans with piggyback second liens

o ABS investors generally rely on rating agencies or other third parties, who may face conflicting incentives

Transactions Costs

Transactions costs include due diligence and legal expenses; costs associated with structuring and negotiating contract terms; and costs associated with sale of the security

Fixed costs per loan included in an issue and fixed costs per issue imply higher transactions costs for smaller loans and smaller institutions

Other Factors Influencing the Loan Sale/Securitization Decision

Risk diversification o Banking institutions, particularly smaller institutions, may sell

loans to reduce concentrations of credit risk in the asset portfolio

o Banks may sell loans with particular duration characteristics as an interest rate risk management strategy

Predatory lending risko Investors may be reluctant to touch HOEPA loans or other loans

with very high interest rates or fees due to legal risks

Data and Empirical Approach

We analyze the disposition (retention vs. sale) of subprime loans originated during 2004-2006, using loan-level HMDA datao The population is limited to loans originated by commercial banks,

savings banks, and credit unions (depository institutions)

o Loans sold to an affiliated institution are excluded

o The population is limited to first lien, home purchase or refinance mortgages (amounts < $1,000,000)

o Subprime loans are defined to be “high cost” (having a HMDA-reported APR spread), or originated or purchased by a HUD-identified subprime specialist


These data are merged at the tract-level with housing and mortgage market variables from several sourceso Aggregated tract-level characteristics from HMDA, such as

percent of loans that are high cost o Aggregate ZIP code level subprime market characteristics from

LoanPerformance, such as percent of loans that are high LTVo The data are transformed to tract-level by weighting proportionately

across ZIP codes that overlap each Census tract o Data are from the LoanPerformance Servicing (not Securities)

database

o MSA house price appreciation (OFHEO index), and MSA housing starts (from economy.com)

o The number of owner-occupied units in the Census tract, from the 2000 U.S. Census


We analyze the disposition of the loan in relation to the size of the APR spread and proxies for various dimensions of credit risk, along with a number of control variables

The APR spread provides a direct test of regulatory capital arbitrageo Regulatory capital arbitrage implies an inverse relationship

between the APR spread (priced risk) and likelihood of sale

A reversal of this relationship during 2005-2006 would suggest an impact of euphoria in the securitization market


Along particular dimensions where banks have informational advantages, we expect likelihood of sale to increase with risk

Variables used to assess bank informational advantages include:o Loan for non-primary residence

o Ratio of loan amount to borrower income

o Local area house price appreciation rate


Model 1: we test for bank informational advantages using a number of local mortgage and housing market variableso Percent of loans in the Census tract that are subprimeo Percent of loans in the Census tract that are non-primary residence

(investment property or second home)o Percent of the Census tract’s subprime loans that are originated by

subprime specialistso Housing market depth (log number of tract owner occupied units)o Local area percent change in housing starts

Model 2: we test for informational advantages using the the future (third quarter 2007) default rate in the Census tract (in place of the above)


We distinguish between home purchase and refinance

Control variables include:o Loan size

o Institution size

o Type of depository institution

o Thrift vs. commercial bank

o HUD-identified subprime specialist

o Metropolitan area dummy variable

o Percent of tract subprime loans that are junior lien

o Percent of tract subprime loans that are high LTV (LTV 90)

Overview of the Data: Sample Size

Home Purchase Refinance

2004 2005 2006 2004 2005 2006

HMDA subprime loan count 196,012 298,402 350,281 286,097 330,025 345,293

After merging with LoanPerformance data 162,977 254,343 296,198 237,170 278,593 288,171

Number missing loan-to-income ratio 7,727 9,873 14,466 3,604 4,479 11,917

Number missing some tract-level data

502 521 2,852 584 472 4,085

Final Sample Size

154,748 243,949 278,880 232,982 273,642 272,169

Percent without sufficient data on 2007 tract delinquency rate

28.5 19.9 25.5 19.2 18.7 30.8

Percent non-Metro 13.5 12.3 12.5 13.3 12.6 12.7

Overview of the Data: Disposition of Home Purchase Loans

Disposition of loans at non-specialist depository institutions

0%

20%

40%

60%

80%

100%

2004 2005 2006

Sold to non-aff iliatedepository

Sold to non-aff iliatenon-depository

Sold to aff iliate

Not sold

Disposition of loans at subprime specialist insititutions

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

Disposition of loans at non-specialist non-depository

institutions

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

Overview of the Data: Disposition of Refinance Loans

Disposition of loans at non-specialist depository institutions

0%

20%

40%

60%

80%

100%

2004 2005 2006

Sold to non-aff iliatedepository

Sold to non-aff iliatenon-depository

Sold to aff iliate

Not sold

Disposition of loans at subprime specialist insititutions

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

Disposition of loans at non-specialist non-depository

institutions

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

Overview of the Data: Structure of the Loan Origination Market

Distribution of high-cost loans by institution category: home purchase

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

non-specialist non-depositorynon-specialistdepositorySubprime specialistnon-depositorySubprime specialistdepository

Distribution of high-cost loans by institution category: refinance

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

non-specialist non-depositorynon-specialistdepositorySubprime specialistnon-depositorySubprime specialistdepository


Distribution of home purchase loans by originator total assets: non-specialist depository

0%10%20%30%40%50%60%70%80%90%

100%

2004 2005 2006

> $100 billion

$1 - 100 billion

< $1 billion

Distribution of home purchase loans by originator total assets: non-

specialist non-depository

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

Distribution of home purchase loans by originator total assets: subprime

specialist

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006


Distribution of refinance loans by originator total assets: non-specialist depository

0%10%20%30%40%50%60%70%80%90%

100%

2004 2005 2006

> $100 billion

$1 - 100 billion

< $1 billion

Distribution of refinance loans by originator total assets: non-specialist non-depository

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

Distribution of refinance loans by originator total assets: subprime

specialist

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

Overview of the Data: APR Spreads

Percent of subprime specialist loans with HMDA-reported APR spreads: home purchase

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

2004 2005 2006

% ratespread

Percent of subprime specialist loans with HMDA-reported APR spreads: refinance

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

2004 2005 2006

% ratespread

Market Context: Interest Rate Trends

Source: Federal Reserve Bank of St. Louis

1 and 10 Year Treasury Rates

0.00

1.00

2.00

3.00

4.00

5.00

6.00

Jan-

04

Apr-0

4

Jul-0

4

Oct-0

4

Jan-

05

Apr-0

5

Jul-0

5

Oct-0

5

Jan-

06

Apr-0

6

Jul-0

6

Oct-0

6

1-year treasury

10-year treasury

Overview of the Data: APR Spreads

Mean APR spread for high cost loans by institution type: home purchase

0

1

2

3

4

5

6

7

2004 2005 2006

Subprime specialist

Non-specialistdepository institution

Non-specialist non-depository

Mean APR spread for high cost loans by institution type: refinance

0

1

2

3

4

5

6

2004 2005 2006

Subprime specialist

Non-specialistdepository institutionNon-specialist non-depository

Overview of the Data: Product Type

Product mix: home purchase

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

ARM

FRM

Hybrid 2/25 or 3/27

Other hybrid

Other

Balloon

Product mix: refinance

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2004 2005 2006

ARM

FRM

Hybrid 2/25 or 3/27

Other hybrid

Other

Balloon

Overview of the Data: Documentation Level, LTV, and FICO

Documentation level, LTV, and FICO: home purchase

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

2004 2005 2006

low /nodocumentation

LTV >= 90

FICO > 620

low /nodocumentation(w eighted)

Documentation level, LTV, and FICO: refinance

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

2004 2005 2006

low /nodocumentation

LTV >= 90

FICO > 620

low /nodocumentation(w eighted)

Market Context: Piggyback Lending Trends

Source: HMDA data with matched first/second liens obtained from Federal Reserve Board

0

10

20

30

40

50

60

2004 2005 2006

Percent of Subprime Loans Originated with a Piggyback Second

Home purchase

Refinance

Overview of the Data: Ratio of Loan Amount to Income

Average ratio of loan amount to income by type of institution: refinance

1

1.25

1.5

1.75

2

2.25

2.5

2.75

3

2004 2005 2006

Subprimespecialist

Non-specialistdepository

Non-specialistnon-depository

Subprimespecialistratespread only

Average ratio of loan amount to income by type of institution: home purchase

1

1.25

1.5

1.75

2

2.25

2.5

2.75

3

2004 2005 2006

Subprimespecialist




Overview of the Data: Average Loan Size

Average loan size by type of institution: refinance

0

50,000

100,000

150,000

200,000

250,000

2004 2005 2006

Subprimespecialist




Average loan size by type of institution: home purchase

0

50,000

100,000

150,000

200,000

250,000

2004 2005 2006

Subprimespecialist




Overview of the Data: Investor Loans (non-primary residence)

Percent of loans for non-primary residence by type of institution: home purchase

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

2004 2005 2006

Subprime specialist


Non-specialist non-depository

Subprime specialistratespread only

Percent of loans for non-primary residence by type of institution: refinance

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2004 2005 2006

Subprime specialist

Non-specialistdepositoryNon-specialist non-depositorySubprime specialistratespread only

Overview of the Data: Housing Market Conditions

-15

-10

-5

0

5

10

15

2004 2005 2006

Housing market variables

% change in OFHEOindex

% change in housingstarts

Empirical Results

Model 1: tract-level variables proxy for localized informational advantages

Model 2: future default rate in tract proxies for localized informational advantages

Estimated separately for home purchase and refinance in 2004, 2005, and 2006

Home Purchase Loans: Model 1

Odds Ratio (Chi-Square) Variable Name

Definition

2004 2005 2006

Rate1 APR spread in [3.0, 3.25) 7.02 (685.3)* 1.47 (80.7)* 0.616 (363.9)* Rate2 APR spread in (3.25,5.25] 3.36 (274.9)* 2.11 (352.2)* 0.698 (252.4)* Rate3 APR spread in (5.25,7.0] 1.87 (67.4)* 2.37 (455.0)* 1.63 (448.5)* Invest Loan for non-primary residence 0.716 (271.0)* 0.684 (470.9)* 0.686 (702.8)* Loan inc ratio Ratio of loan amount to borrower

income 1.21 (715.4)* 1.30 (1736.7)* 1.17 (795.0)*

APPR(YR) Annual rate of change in local area HPI in year 1.45 (13.0)* 0.228 (399.3)* 0.253 (117.0)*

MSASTARTS(YR) Annual rate of change in local area housing starts in year 0.562 (124.9)* 0.505 (348.1)* 0.768 (59.4)*

Tract % Specialist Subprime specialist share of subprime loans in tract 3.68 (696.6)* 2.83 (387.1)* 1.64 (100.2)*

Tract % high cost Fraction of tract loans that are high cost 1.51 (42.2)* 1.70 (145.5)* 1.89 (251.8)* Tract % invest Fraction of Census tract’s home

purchase loans that are non-owner 1.28 (19.2)* 1.25 (25.8)* 0.806 (31.0)*

Log owner units Log of Census tract owner-occupied units 0.888 (109.3)* 0.877 (174.3)* 0.866 (299.7)*

Metro Property in an MSA 1.08 (12.0)* 1.19 (101.9)* 1.24 (202.2)* Lnsize1 Loan amount < $55,000 0.807 (46.5)* 0.532 (575.1)* 0.754 (155.6)* Lnsize2 Loan amount in [$55,000, $155,000) 1.84 (703.1)* 1.21 (97.4)* 1.70 (1142.2)* Lnsize3 Loan amount in [$155,000, 255,000) 1.52 (343.0)* 1.20 (90.5)* 1.46 (626.1)* Thrift Lender is S&L or savings bank 1.49 (339.2)* 3.25 (3524.6)* 1.20 (201.7)* Credit Union Lender is credit union 1.10 (2.5) 1.61 (93.7)* 0.960 (0.7) Specialist rate0 Lender is subprime specialist; loan not

high cost 18.41 (1243.6)* 2.78 (160.9)* 0.642 (33.7)*

Specialist Lender is subprime specialist 3.54 (4202.7)* 5.79 (6911.0)* 4.83 (5762.2)* BkSize1 Bank assets < $1 billion 0.280 (2487.6)* 0.319 (2770.3)* 0.337 (3410.9)* BkSize3 Bank assets > $100 billion 3.74 (3975.0)* 5.28 (8154.8)* 4.32 (12726.4)* % LTV GT 90 Fraction of Census tract’s subprime

home purchase loans with LTV 90 2.69 (146.2)* 1.68 (45.4)* 3.08 (362.5)*

Tract % second Fraction of tract’s high cost home purchase loans that are 2nd lien 1.15 (8.9)* 3.58 (479.0)* 4.95 (1066.4)*

C-statistic 0.846 0.867 0.832

Refinance Loans: Model 1


Definition

2004 2005 2006

Rate1 APR spread in [3.0, 3.25) 2.38 (229.9)* 0.607 (206.9)* 0.138 (8018.0)* Rate2 APR spread in (3.25,5.25] 1.73 (95.0)* 1.07 (4.3)** 0.240 (5465.6)* Rate3 APR spread in (5.25,7.0] 1.48 (44.5)* 1.58 (194.0)* 0.855 (62.0)* HOEPA Indicator for HOEPA loan 0.241 (119.4)* 0.166 (171.3)* 0.138 (172.1)* Invest Loan for non-primary residence 0.810 (115.0)* 0.772 (158.2)* 1.03 (2.5)

Loan inc ratio Ratio of loan amount to borrower income

1.17 (947.7)* 1.24 (1972.7)* 1.19 (1489.9)*

APPR(YR) Annual rate of change in local area HPI in year

0.488 (92.0)* 0.315 (309.3)* 0.339 (78.9)*

MSASTARTS(YR) Annual rate of change in local area housing starts in year

0.603 (158.5)* 0.799 (45.5)* 0.697 (114.6)*

Tract % Specialist Specialist share subprime loans in Census tract

5.04 (2029.8)* 5.97 (1563.6)* 2.77 (528.7)*

Tract % high cost Fraction of tract loans that are high cost 1.47 (60.0)* 1.84 (240.7)* 2.03 (343.5)*

Tract % invest Fraction of Census tract’s home purchase loans that are non-owner

1.72 (167.9)* 1.99 (289.2)* 1.66 (175.6)*

Log owner units Log of Census tract owner-occupied units

0.988 (1.8) 0.974 (8.5)* 0.990 (1.6)

Metro Property in an MSA 1.43 (466.9)* 1.62 (898.7)* 1.44 (585.0)* Lnsize1 Loan amount < $55,000 0.313 (2084.9)* 0.153 (5599.4)* 0.217 (4855.4)*

Lnsize2 Loan amount in [$55,000, $155,000) 1.06 (11.8)* 0.747 (316.6)* 0.843 (149.5)*

Lnsize3 Loan amount in [$155,000, 255,000) 1.14 (57.5)* 0.931 (21.5)* 1.04 (8.9)*

Thrift Lender is S&L or savings bank 0.434 (2720.0)* 0.387 (1950.7)* 0.691 (777.0)*

Credit Union Lender is credit union 0.400 (420.4)* 0.433 (269.8)* 0.676 (52.7)* Specialist rate0 Lender is subprime specialist; loan not

high cost 2.62 (282.1)* 0.789 (45.6)* 0.421 (777.2)*


refinance loans with LTV 90 0.808 (7.2)* 0.843 (4.6)** 0.935 (1.3)

Tract % second Fraction of tract’s high cost refinance loans that are 2nd lien

1.51 (48.6)* 3.01 (275.1)* 2.00 (160.7)*

C-statistic 0.809 0.848 0.788

Home Purchase Loans: Model 2


Definition

2004 2005 2006

Rate1 APR spread in [3.0, 3.25) 7.23 (712.7)* 1.39 (61.3)* 0.585 (453.0)* Rate2 APR spread in (3.25,5.25] 3.48 (294.8)* 2.03 (322.7)* 0.669 (318.3)* Rate3 APR spread in (5.25,7.0] 1.96 (78.2)* 2.30 (432.7)* 1.59 (407.3)* Invest Loan for non-primary residence 0.764 (191.2)* 0.719 (385.3)* 0.693 (732.9)* Loan inc ratio Ratio of loan amount to borrower

income 1.23 (845.1)* 1.32 (1947.4)* 1.19 (929.2)*

APPR(YR) Annual rate of change in local area HPI in year 1.13 (1.3) 0.180 (594.9)* 0.119 (311.4)*

Tract % Bad Subprime 90+ delinquency rate in Census tract as of 2007 Q3 1.94 (33.1)* 3.64 (180.4)* 1.29 (8.1)*

Bad rate dummy Insufficient data for measuring delinquency rate 0.812 (57.2)* 0.990 (0.2) 0.837 (71.6)*

Metro Property in an MSA 1.03 (2.3) 1.19 (93.5)* 1.22 (159.9)* Lnsize1 Loan amount < $55,000 0.909 (10.1)* 0.569 (497.0)* 0.812 (88.9)* Lnsize2 Loan amount in [$55,000, $155,000) 2.02 (1008.6)* 1.27 (162.1)* 1.76 (1340.6)* Lnsize3 Loan amount in [$155,000, 255,000) 1.56 (397.5)* 1.19 (100.4) 1.47 (653.4)* Thrift Lender is S&L or savings bank 1.54 (403.5)* 3.32 (3694.5)* 1.22 (246.8)* Credit Union Lender is credit union 1.10 (2.8) 1.59 (88.8)* 0.942 (1.5) Specialist rate0 Lender is subprime specialist; loan not

high cost 18.27 (1245.2)* 2.56 (137.0)* 0.588 (49.7)*


home purchase loans with LTV 90 1.87 (50.8)* 1.06 (0.5) 2.35 (206.0)*

Tract % second Fraction of tract’s high cost home purchase loans that are 2nd lien 1.09 (3.8) 3.10 (412.6)* 3.84 (826.7)*

C-statistic 0.843 0.866 0.831

Refinance Loans: Model 2


Definition

2004 2005 2006

Rate1 APR spread in [3.0, 3.25) 2.39 (233.4)* 0.593 (227.4)* 0.135 (8348.2)* Rate2 APR spread in (3.25,5.25] 1.72 (94.6)* 1.04 (1.5)* 0.236 (5677.0)* Rate3 APR spread in (5.25,7.0] 1.47 (43.3)* 1.55 (182.7)* 0.851 (66.9)* HOEPA Indicator for HOEPA loan 0.232 (126.0)* 0.166 (171.7)* 0.133 (179.4)* Invest Loan for non-primary residence 0.855 (66.4)* 0.829 (86.0)* 1.07 (18.9)* Loan inc ratio Ratio of loan amount to borrower

income 1.18 (1099.3)* 1.25 (2219.1)* 1.20 (1653.5)*

APPR(YR) Annual rate of change in local area HPI in year 0.581 (57.3)* 0.440 (168.4)* 0.203 (185.1)*

Tract % Bad Subprime 90+ delinquency rate in Census tract as of 2007 Q3 2.11 (75.6)* 5.48 (382.9)* 1.42 (15.9)*

Bad rate dummy Insufficient data for measuring tract delinquency rate 0.745 (187.1)* 0.857 (52.5)* 0.798 (125.8)*

Metro Property in an MSA 1.38 (345.6)* 1.58 (772.5)* 1.39 (476.4)* Lnsize1 Loan amount < $55,000 0.354 (1820.1)* 0.166 (5618.1)* 0.239 (4596.7)* Lnsize2 Loan amount in [$55,000, $155,000) 1.19 (103.7)* 0.803 (197.5)* 0.915 (43.4)* Lnsize3 Loan amount in [$155,000, 255,000) 1.19 (105.2)* 0.955 (9.2) 1.09 (46.1)* Thrift Lender is S&L or savings bank 0.449 (2560.1)* 0.402 (1813.0)* 0.699 (741.0)* Credit Union Lender is credit union 0.395 (429.3)* 0.440 (258.7)* 0.683 (50.5)** Specialist rate0 Lender is subprime specialist; loan not

high cost 2.51 (259.3)* 0.750 (67.5)* 0.411 (840.0)*


home purchase loans with LTV 90 1.02 (0.0) 0.700 (20.7)* 0.949 (0.8)

Tract % second Fraction of tract’s high cost home purchase loans that are 2nd lien 1.05 (0.8) 1.73 (81.3)* 0.983 (0.1)

C-statistic 0.806 0.847 0.787

Empirical Results: Shifting Relationship to APR Spread

Likelihood of sale declines with APR spread in 2004, consistent with regulatory capital arbitrage

Likelihood of sale generally increases with APR spread in 2005 and 2006, consistent with undervaluing of credit risk in ABS markets

Empirical Results: Shifting Relationship to APR Spread

Relative odds of loan sale by APR category:Home Purchase

012345678

APR spreadin [3.0, 3.25]

APR spreadin (3.25, 5.25]

APR spreadin (5.25, 7.0]

APR sread >7.0, non-HOEPA

2004

2005

2006

Relative odds of loan sale by APR category: Refinance

0

1

2

3

4

APR spread in[3.0, 3.25]

APR spread in(3.25, 5.25]

APR spread in(5.25, 7.0]

APR sread >7.0, non-HOEPA

HOEPA

2004

2005

2006

Empirical Results: Bank Informational Advantages

Likelihood of sale is inversely related to local area house price appreciation and percent change in housing startso Suggests that banks may incorporate more local and regional

economic data into their decision processes than aggregators/asset managers/investors

o Home purchase in 2006 is exception


Loans for non-primary residence are less likely to be soldo Consistent with relationship lending or with specialized

information regarding local investment opportunities o Refinance in 2006 is exception

Likelihood of sale increases with ratio of loan amount to borrower incomeo Consistent with more cautious assessment of debt payment

capacity (model overrides)


Likelihood of sale increases with:o Percent of tract loans that are subprime

o Percent of tract loans that are non-primary residence

o Percent of tract subprime loans that are originated by subprime specialists

o Consistent with asymmetric information concerning neighborhood risk factors

o Alternatively, to the extent that borrowers with similar risk profiles tend to cluster geographically, may reflect asymmetric information concerning borrower-specific risks


For home purchase loans, likelihood of sale is inversely related to number of owner occupied units in neighborhoodo Consistent with superior information regarding appraisal accuracy

In model 2, a higher neighborhood delinquency rate ex-post (in Q3 2007) is associated with increased likelihood of sale

Other Empirical Results

Likelihood of sale increases with percent of tract subprime loans that are junior lien

Likelihood of sale increases with percent of tract subprime loans that are high LTV (only for home purchase loans)

Likelihood of sale reduced for HOEPA loans and those in the highest APR spread categoryo Consistent with legal risks


Large home purchase loans are less likely to be sold

Very small loans are less likely to be soldo Fixed transactions costs per securitization

Very small institutions tend not to sello Fixed costs associated with access to securities market or other

loan sale channels

Loans outside metro areas less likely to be sold


Purchase and refinance loans exhibit somewhat different patterns of loan disposition in relation to type and size of institutiono May reflect differing diversification requirements; differing roles

of relationship lending

Robustness

• Results (models 1 and 2) are robust to:o Adding dummy variables for Census Divisions

o Including observations with missing income (setting the loan-to-income ratio=0 and using a dummy variable)

o Excluding loans sold to other depository institutions

o Any of these changes has little impact on sign, magnitude, or statistical significance of other variables

Robustness

Model 1 is robust to inclusion of additional ZIP-code level

measures of subprime market composition o Product mix

o Percent of tract subprime loans that are to lower FICO borrowers (FICO score < 620)

o Including these has little impact on sign, magnitude, or statistical significance of other variables

o No consistent relationship to loan disposition observed for any of these

Robustness

Model 1 is robust to excluding the measures of subprime market composition from LoanPerformance data Using either the full HMDA sample before merging with

LoanPerformance data, or the smaller merged sample

Model 2 is robust to excluding the tract-level control variables

Conclusions

We obtain evidence suggestive of euphoria-driven undervaluing of credit risk in ABS markets during 2005-06o In 2004, depository institutions were less likely to sell subprime

loans with larger APR spreads, consistent with regulatory capital arbitrage

o In 2005-06, we observe a reversal of this relationship

We also obtain evidence suggestive of informational advantages of depository institutionso Likelihood of sale increases with ratio of loan amount to borrower income

o Likelihood of sale related to a variety of neighborhood risk factors

Conclusions

Some caveats applyo Relationship between loan disposition and APR spread may have

been affected by shifting yield curve

o We cannot observe whether banks offered greater credit enhancements on riskier loans

securitization of subprime mortgages an empirical analysis of the loan sale decisions of depository...

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