Did SFAS 166/167 decrease the information asymmetry of securitizing banks?

• Author: Seda Oz
• DOI: http://doi.org/10.1111/fire.12217
• Published date: 01 November 2020
• Date: 01 November 2020

DOI: 10.1111/fire.12217

ORIGINAL ARTICLE

Did SFAS 166/167 decrease the information

asymmetry of securitizing banks?

Seda Oz

School of Accounting and Finance, University of

Waterloo,Waterloo, Ontario, Canada

Correspondence

SedaOz, School of Accounting and Finance,

Universityof Waterloo, 200 University Avenue

West,Waterloo, ON N2L 3G1, Canada.

Email:seda.oz@uwaterloo.ca

Thispaper is based on the author’s dissertation

atthe New York University.The author greatly

appreciatesthe invaluable guidance and support

fromher dissertation committee members: Yakov

Amihud,Mary Billings, Michael Jung, Joshua

Ronen(chair), and Stephen Ryan. An earlier ver-

sionof this paper was circulated under the title:

“DidFAS 166/167 Improve the Transparencyof

SecuritizingBanks?”.

Abstract

Beginning in 2010, mandated Financial Accounting Standards No.

166 and 167 (SFAS 166/167) changed the consolidation rules of

securitization entities and required more information about their

securitization activities. I find that securitizing banks experienced a

decrease in information asymmetry from the pre- to the post-SFAS

166/167 periods, and that more visible securitizing banks are less

sensitive to SFAS166/167. These inferences are robust to a number

of sensitivity analyses. This study is one of the first to provide evi-

dence of the effects of SFAS166/167 on the information asymmetry

of securitizing banks.

KEYWORDS

banks, disclosure, FAS166, FAS 167, information asymmetry, regula-

tions, securitizations, SFAS166, SFAS 167

JEL CLASSIFICATIONS

D80, G21, G28, M41

1INTRODUCTION

In June 2009, the Financial Accounting Standards Board (FASB) issued statement of financial accounting standards

(SFAS)No. 166 (Accounting for Transfers of Financial Assets) and SFAS No. 167 (Amendments to FASBInterpretation

No. 46[R]). The primary objective of these two standards was to improve financial reporting about transfers of finan-

cial assets, a transferor’s continuing involvement with transferred financial assets (SFAS166, 2009), and an entity’s

involvement in a variable interest entity (VIE) (SFAS167, 2009). Although all firms are subject to SFAS 166 and SFAS

167, these standards primarily affect holders of asset-backed securities (ABS).

The aim of this study is to answer whether the “financial reporting improvements” mandated bySFAS 166 and SFAS

167 (SFAS 166/167, hereafter) resulted in the conveyance of greater transparencyabout ABS to investors. ABS are

created bybuying and bundling loans—such as residential mortgage loans, commercial loans, and consumer loans—and

creating securities backed bythose assets, which are then sold to investors. ABS are the cornerstone of securitization,

Financial Review.2020;55:557–581. wileyonlinelibrary.com/journal/fire c

2019 The Eastern Finance Association 557

558 OZ

which is the process of issuing, organizing, or initiating these securities to retain an economic interest in a material

portion of the credit risk for any asset that securitizers transfer,sell, or convey to a third party.

Prior to the financial crisis, securitization had become one of the defining features of the financial landscape. Banks

were essentially underwriters of their own loans and investors in other banks’ securitized assets. Securitization was

thought to have stimulated loan supply, increased the liquidity of banks’ balance sheets, allowed a broader rangeof

investors to access a class of assets hitherto limited to banks, and, by increasing risk diversification,to have improved

financial stability (Duffie, 2008).

In 2007, the burst of the housing bubble in the United States and the collapse of the subprime mortgage

market ignited a severe global financial crisis. The market for securitized assets shriveled, as securitization was

blamed for financial instability and received an unprecedented amount of attention from regulators and mar-

ket participants. For instance, in 2009, George Miller, Executive Director of the American Securitization Forum

(ASF), wrote in testimony for The United States Senate Committee on Banking, Housing, and Urban Affairs

(2010, Senate Report 111-176) that “ASF supports increased transparency and standardization in the securiti-

zation markets, and related improvements to the securitization market infrastructure.” As a response, the FASB

tightened the consolidation requirements for securitizations and issued SFAS 166/167. These two standards cre-

ated drastic changes in the financial reporting of entities with ABS. For instance, the Federal Reserve Bank of St.

Louis (2011) reported that as of March 31, 2010, adoption of these two new accounting standards led domesti-

cally chartered U.S. banks to consolidate more than $350 billion of assets. Despite these drastic changes in the

financial statements, there is an open empirical question. Do SFAS 166/167 actually remove (any) asymmetric

information frictions regarding securitization transactions? Answering this question is the main objective of this

study.

Further,the analysis of the impact of SFAS 166/167 allows me to shed light on the state of securitization transac-

tions in the post-crisis period. The link between banks’ information environment and the off-balance sheet treatment

of ABS has been one of the most fundamental issues for accounting and finance scholars, and lack of disclosure made

it impossible for investors in ABS to assess the risks of the underlying assets during the financial crisis of 2007–2009.

This resulted in an interbank lending freeze and a constriction of the general flow of credit (The United States Senate

Committee on Banking, Housing, and Urban Affairs, 2010, Senate Report 111-176). The financial crisis of 2007–2009

and the wave of regulatory changes following the crisis (e.g., SFAS166/167, Dodd–Frank Act) changed the face of the

securitized banking system as we know it. It is crucial to understand the current standing of this industry,and how SFAS

166/167 might have contributed to this change.

My first hypothesis is that SFAS166/167 decreases the information asymmetry of banks that report ABS. I test my

first hypothesis using a set of bank holding companies (BHCs) that report ABS from Q1 2001 until Q4 2018. I regress

information asymmetry, proxied by bid-ask spread, and effectivebid-ask spread on total ABS, a post-SFAS 166/167

dummy variable, the interaction of these two variables, and a host of control variables to control for differences such

as size, capital requirements, loan portfolio, risk profile, tradingvolume, and market sentiment. My results indicate that

the positive association between ABS and information asymmetry is weaker in the post-SFAS166/167 period, which

suggests that these new standards improved transparency.

Second, I examine whether the impact of SFAS 166/167 on securitizing banks is weakerin more visible securitiz-

ing banks. More visible banks attract more attention and scrutiny in the financial market. Thus, these banks are more

careful with their reporting practices, which include reporting additional and clearer information about securitization

transactions, regardless of the new standards. Using bank size, analyst coverage,and the rank of a bank’s market value

as measures of bank visibility,I find that more visible securitizing banks are less sensitive to SFAS 166/167.

It is tempting to attribute myresults solely to the relief started at the end of the financial crisis of 2007–2009, rather

than to the improved disclosure practices. Toprovide further assurance that this association is partially due to SFAS

166/167, I employ a propensity score matching model, building a control sample using nonsecuritizing banks. Non-

securitizing banks do not engage in transfers of financial assets and, because SFAS 166/167are i ntended to improve

disclosures about transferredfinancial assets, nonsecuritizingbanks are not expected to be affected by SFAS 166/167.