Introduction to Securitization

INCREASES OPAQUENESS OF BANK RISK

Another major concern with securitization is that it masks the risks to which a bank is exposed when assets are securitized but there are significant retained risks. The retained risks are not easily identified by an examination of the bank’s balance sheet. Rather these retained risks are reflected in the economic value of retained or residual interests in the bank’s securitization transactions.

After a securitization is completed, a bank retains the risk/reward profile associated with the residual cash flow (i.e., the cash flow after making payments to the investors in the asset-backed securities and ongoing fees associated with the securitization). The residual interest appears on the balance sheet of the securitizer but must be marked to market. There is no market where the value of the residual interest can be obtained. Rather, the determination of the value of the residual interest, both at the time of the securitization and thereafter, is estimated using the standard discounted cash flow analysis based on several assumptions. This can result in material differences in the value of the residual interest depending on the assumptions used. The failures of at least three U.S. banks—Superior Bank, First National Bank of Keystone, and Pacific Thrift and Loan—were caused by the alleged improper valuation of the residual interests or, equivalently, the improper appreciation of the risk on securitized assets.⁶⁹

Consider for example the case of ...