To Securitize or to Price Credit Risk?

Abstract

The JENA ECONOMIC RESEARCH PAPERS is a publication of the Friedrich Schiller University Jena, Germany (www.jenecon.de).

Climate Change Risk and the Cost of Mortgage Credit

“…33 Lenders in general tend to adhere to the GSE pricing guidelines when determining the interest rate on a GSEeligible loan because a failure to do so may prevent them from selling a loan to the GSEs, thereby reducing loan portfolio liquidity (Loutskina, 2011). Consistent with this, Hurst et al (2016) find that GSE loans' interest rates do not vary with historic mortgage default rates and McGowan and Nguyen (2021) show that foreclosure laws do not have any effect on GSE loans' interest rates. However, lenders may occasionally quote an interest rate spread that is above what is suggested by the pricing grid for non-credit reasons, such as to exploit its monopoly position in the local area or to extract rent from borrowers who are less likely to shop around (Bartlett et al, 2022).…”

“…The GSEs provide a pricing grid which helps bank determine the credit risk premium charged by the GSEs. 31 Specifically, the pricing of GSE-eligible loans is subject to the GSEs' constant interest rate policy in which interest rates vary based on a borrower's observable credit score, loan-to-value ratio, and other observable borrower characteristics, but exclude factors that systematically affect credit risk across regions (Hurst et al 2016;McGowan and Nguyen, 2021). 32 Thus, the interest rates devised from a GSE's pricing-grid are unlikely to reflect SLR risk.…”

The Color of Corporate Loan Securitization

“…Gorton and Pennacchi (1995) model a bank's choice between selling and holding loans and show that moral hazard associated with loan securitization could be reduced if banks hold a certain fraction of a loan. Empirically, McGowan and Nguyen (2022) show that banks transfer credit risk through securitization when loan purchasers do not price the risk correctly. These predictions on the determinants of loan sales have implications beyond banks' monitoring of credit risk.…”

“…Since our discussion of existing theories and empirical evidence show that banks may securitize loans to transfer transition risk to loan purchasers (Gorton and Pennacchi, 1995;McGowan and Nguyen, 2022;Parlour and Winton, 2013), one would expect that any shocks that change the level of transition risk would have an impact of loan securitization.…”

“…Early literature theoretically predicts when banks sell loans on secondary markets (Gorton and Pennacchi, 1995;Pennacchi, 1988). Empirical works show that banks sell off high credit risk loans when they have to hold costly equity capital against their credit exposures (Parlour and Winton, 2013) and when loan purchasers do not price the risk correctly (McGowan and Nguyen, 2022). We depart from this literature by focusing on how banks choose between securitization and adjusting loan terms when they face climate transition risks.…”