The Real Effects of FAS 166/167 on Banks’ Mortgage Approval and Sale Decisions

• Author: BIQIN XIE,YIWEI DOU,STEPHEN G. RYAN
• DOI: http://doi.org/10.1111/1475-679X.12204
• Date: 01 June 2018
• Published date: 01 June 2018

DOI: 10.1111/1475-679X.12204

Journal of Accounting Research

Vol. 56 No. 3 June 2018

Printed in U.S.A.

The Real Effects of FAS 166/167 on

Banks’ Mortgage Approval and Sale

Decisions

YIWEI DOU,

∗STEPHEN G. RYAN,

∗AND BIQIN XIE

†

Received 11 July 2016; accepted 12 January 2018

ABSTRACT

We examine the real effects of FAS166 and FAS 167 on banks’ loan-level mort-

gage approval and sale decisions. Effective in 2010, these standards tightened

the accounting for securitizations and consolidation of securitization entities,

respectively, causing banks to recognize an estimated $811 billion of securi-

tized assets on balance sheet. We find that banks that recognize more secu-

ritized assets exhibit larger decreases in mortgage approval rates and larger

increases in mortgage sale rates. These effects significantly exceed those of

banks’ off–balance sheet securitized assets, consistent with our results being

driven by the consolidation of securitization entities rather than by securiti-

zation per se. We conduct tests that help rule out the financial crisis as an

alternative explanation for our results. Further analyses suggest that mecha-

nisms underlying the results include consolidating banks’ reduced regulatory

∗New York University; †Pennsylvania State University.

Accepted by Douglas Skinner. We acknowledge helpful comments from two anony-

mous referees, Anne Beatty (discussant), Remington Curtis (discussant), Kai Du, Dan

Givoly, Guojin Gong, Yihong Jiang, Jed Neilson, Hong Qu, and Phillip Stocken, as well

as workshop participants at the Pennsylvania State University accounting brown-bag sem-

inar and Accounting Research Conference, the HEC Lausanne and Lancaster University

accounting research seminars, Shanghai University of Finance and Economics, the Macro

Financial Modeling 2017 Winter Meeting, and the 2017 AAA Annual Meeting. An on-

line appendix to this paper can be downloaded at http://research.chicagobooth.edu/arc/

journal-of-accounting-research/online-supplements.

843

Copyright C, University of Chicago on behalf of the Accounting Research Center,2018

844 Y.DOU,S.G.RYAN,AND B.XIE

capital adequacy, increased market discipline, and consequent desire not to

recognize high-risk mortgages on balance sheet.

JEL codes: G21; M41

Keywords: variable interest entities; consolidation; banks; mortgage

approval; mortgage sale

1. Introduction

We examine the real effects of FAS 166 and FAS 167 on the mortgage

approval and sale decisions of U.S. commercial bank holding companies

(hereafter, “banks”).1Effective at the beginning of 2010, FAS 166 and

FAS 167 tightened the rules governing accounting for securitizations and

the consolidation of variable interest entities (VIEs), respectively. Most of

banks’ VIEs are securitization entities. Under the previous VIE consolida-

tion standard, FIN 46(R), banks rarely consolidated these entities even

when they bore most of the entities’ risk. We estimate that our sample

banks consolidated VIEs holding assets of $811 billion, 5.6% of the total

assets of all banks, under FAS 166/167. Of these newly consolidated assets,

about 10% were held by asset-backed commercial paper (ABCP) conduits

and 80% by other types of securitization entities, mostly credit card master

trusts. This new VIE consolidation under FAS 166/167 effectively increased

consolidating banks’ regulatory capital requirements, because bank regu-

lators decided to include the assets (and associated loan loss reserves) of

all consolidated VIEs in the calculation of regulatory capital ratios (Federal

Deposit Insurance Corporation (FDIC) [2009]).2In justifying this decision,

regulators stated that the consolidation of VIEs under FAS 166/167 “will

result in regulatory capital requirements that better reflect, in many cases,

banking organizations’ exposure to credit risk” (FDIC [2009], p. 11).

Many policy makers and academics argue that undisciplined mortgage

origination by banks and other financial firms during the 2004–2006 credit

1FAS 166, Accounting for Transfersof Financial Assets, amends FAS 140, Accounting for Transfers

and Servicing of Financial Assets and Extinguishments of Liabilities. FAS 167, Amendments to FASB In-

terpretation No. 46(R), amends FIN 46(R), Consolidation of VariableInterest Entities,an Interpretation

of ARB No. 51. FAS 166 and 167 are now codified as parts of Accounting Standards Codifica-

tion (ASC) Sections 860 and 810, respectively. Throughout the paper, we refer to the legacy

standards, as it is simpler than referring to “the amendments of ASC Sections 860 and 810

effective in 2010.”

2Hereafter,we refer to this as the “associated bank regulatory decision.” This decision partly

reflects bank regulators’ passive decision to follow GAAP and partly their active elimination of

the exclusion of consolidated ABCP conduits from risk-weighted assets (FDIC [2004], Acharya

and Ryan [2016], subsection 4.3). To ensure that this elimination does not drive our results,

we exclude bank-year observations with consolidated ABCP conduits from our sample. See

subsections 2.1 and 3.1 for discussion of regulators’ elimination of the ABCP exclusion and

related sample selection criteria, respectively.

THEREALEFFECTSOFFAS166/167 845

boom contributed significantly to the 2007–2009 financial crisis3(e.g., Fi-

nancial Crisis Inquiry Commission [2011]). Recent regulatory reforms gen-

erally increased bank capital requirements under the view that higher cap-

ital enhances financial stability (Office of the Comptroller of the Currency

[2013]). As discussed below, we provide evidence that new VIE consolida-

tion under FAS 166/167 reduces banks’ mortgage approval rates, consis-

tent with this view.

On the other hand, the financial sector also includes the shadow bank-

ing system, which performs certain credit intermediation functions similar

to those of banks but is subject to lesser or no capital requirements. The

shadow banking system includes government-sponsored enterprises (GSEs)

that purchase and securitize residential mortgages and bank-like financial

services firms that employ securitization-based originate-to-distribute busi-

ness models (Pozsar et al. [2010], Acharya [2012]).4Some regulators and

academics criticize the recent regulatory reforms, arguing that higher capi-

tal requirements cause loan and other banking risks to migrate from banks

to the less regulated shadow banking system (Kashyap, Stein, and Hanson

[2010], Stein [2010], Adrian and Ashcraft [2012], Plantin [2015]).5Since

mortgages sold by regulated banks are often purchased by institutions in

the shadow banking system (Pozsar et al. [2010]), and these institutions typ-

ically securitize the mortgages, the majority of the economic risk of those

sold mortgages is transferred to the shadow banking system (Rosen [2011],

Han, Park, and Pennacchi [2015]). As discussed below, we provide evi-

dence that new consolidation under FAS 166/167 increased banks’ mort-

gage sales, supporting this concern.

We estimate that FAS 166/167 on average reduced new VIE consolidat-

ing banks’ tier 1 risk-based capital ratio by about 1%.6In contrast, FAS

166/167 does not directly affect the capital adequacy of banks whose secu-

ritization entities remain unconsolidated or that do not engage in securi-

tization. Variation in the impact of the standards within securitizing banks

and across securitizing versus nonsecuritizing banks enables us to employ a

difference-in-differences research design to test whether VIE consolidation

leads banks to decrease their mortgage approval rates and increase their

mortgage sale rates.

We measure the impact of FAS 166/167 as the ratio of the assets held

by a bank’s consolidated VIEs to the difference between the bank’s total

3Tobe precise, the credit boom ended in June 2007 and the financial crisis began in earnest

a month or two later (Ryan [2008]). As we examine annual data, we refer to the financial crisis

as occurring in 2007–2009.

4Pozsar et al. [2010] report total shadow bank liabilities of $16 trillion in 2010Q1, more

than traditional bank liabilities of $13 trillion.

5For example, Kashyap, Stein, and Hanson [2010, p. 2] warn “the danger is that, in the face

of higher capital requirements, these same forces of competition are likely to drive a greater

volume of traditional banking activity into the so-called ‘shadow banking’ sector.”

6In comparison, this decrease in the tier 1 capital ratio is about three times Berger et al.’s

[2008, p. 137] estimate that banks on average manage that ratio upwards by 35 basis points.