Abstract
Corporate income taxation, by affecting the after-tax cost of funding, has implications for a bank’s incentive to securitize. Using a sample of OECD banks over the period 1999–2006, we find that corporate income taxation led to more securitization at banks that are constrained in funding markets, while it did not affect securitization at unconstrained banks. This is consistent with prior theories suggesting that the tax effects of securitization depend on the extent to which banks face funding constraints. Our results suggest that current corporate income tax systems have distorting effects on banks’ securitization decisions.
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Notes
Decreased incentives for monitoring and excessive securitization contributed to the increase of systemic risk and eventually the subprime crisis. Nijskens and Wagner (2011) find evidence that banks issuing credit default swaps (CDSs) and collateralized loan obligations (CLOs) pose greater systemic risk.
For example, even though the Indian securitization market grew 15 % in the fiscal year 2012, a pending amendment which made the tax status of pass-through entities uncertain hit the market. “Due to lack of clarity on tax incidence on pass-through vehicles, the securitization business has come to a virtual standstill,” said Vimal Bhandari, CEO of Indostar Capital Finance. See “Tax issue hits securitization market hard” in Indian Express.
In this paper, the definition of securitization is restricted to the off-balance sheet activity of issuing ABS. This definition is much narrower than the general concept which includes selling loans, issuing standby letters of credit and loan commitments.
Despite a general declining trend, corporate income tax rates remain substantially different across countries. For instance, Ireland and Turkey have effective marginal CIT rates below 10 %, whereas Germany and Japan have rates above 35 %.
In practice, tax neutrality is usually accomplished in a variety of ways. First, offshore SPVs are widely used to maintain no taxable presence in originator’s jurisdiction. Set up in tax havens or tax-friendly countries to OECD, such as Cayman Islands, Irish docks and Jersey, SPVs have access to tax avoidance strategies unpermitted at home jurisdictions. Second, SPVs are structured as tax transparent pass-through entities. For instance, treated as tax transparent and pass-through, real estate mortgage investment conduits (REMICs) are generally not taxed in the U.S. Third, SPVs can be designed to have little material income tax liability, i.e., its deductible expenses perfectly offset income, reducing taxable income to zero.
Certain contract features, such as offering implicit recourse, holding equity tranche and over-collateralization, are designed to alleviate the moral hazard problem and to reduce the agency cost of securitization. Consistent with theoretical predictions of reduced incentives to carefully screen and monitor borrowers, some empirical studies find a decline in the credit quality in securitized loans (Keys et al. 2010; Purnanandam 2011; Keys et al. 2012).
Fixed costs usually include the costs associated with setting up SPVs, rating fees, auditing and legal expenses.
Gilje et al. (2013) find that banks experiencing deposits windfalls in U.S. shale-boom counties tend to fund their mortgage lending through low cost deposits instead of securitization.
For instance, the Italian market of securitization had not started growing remarkably until the enactment of Law 130 in 1999.
In practice, small banks with no direct access to ABS markets might sell loans to large institutions that pool and securitize them. This means in some cases the underlying assets of ABS are not originated by the sponsor of ABS, which may bring noises and biases to our analysis. Fortunately, this usually happens in the deals in which large investment banks act as sponsors and are excluded from our sample. Therefore, most securitizing banks in our sample originate loans as the underlying assets and complete off-balance sheet securitization themselves.
Using bank names and countries of residence as a reference, Panetta and Pozzolo (2010) match originators of securitization in Dealogic with banks in Bankscope in a similar study of motivations for bank securitization. They end up with a sample of 696 matched pairs. It is worth noting that their research covers a longer period (1991–2007), more countries (140 countries) and various types of securitization (asset-backed securities (ABSs), mortgage-backed securities (MBSs), collateralized loan obligations (CLOs) and collateralized debt obligations (CDOs)), therefore they have more matched securitizing banks.
We thank the referee for clarifying this point.
Due to data limitation, we have little traceable information of SPVs in most securitization transactions. However, this argument is in line with anecdotal facts that SPVs do have an advantage as long as they are, indeed, truly bankruptcy remote and off balance sheet.
We do not include the bank size into regressions since we have already considered the crucial effect of bank size on securitization and restricted our sample to large banks only.
It is less likely that leverage leads to endogeneity bias in our analysis. First, in the model of Han et al. (2014) in the absence of securitization market, bank leverages are determined by loan and deposit market conditions as well as corporate tax rates. In the securitization decision, it is the trade-off of marginal costs of on and off-balance sheet financing, rather than bank leverage, that determines whether to securitize or not. Therefore, once we include tax rates, the funding constraint dummy, and the interaction of the two, it is unlikely our results are contaminated by omitted variable bias. We also control for other bank level variables, regulatory variables and macroeconomic variables to mitigate the concern of omitted variable bias. Second, securitization may affect bank leverage ex post as loans are removed from balance sheets and bank excess capital decreases. By contrast, in the model of Han et al. (2014) there is no channel through which leverages directly affect securitization. Therefore, we are less worried about reverse causality. In addition, we explicitly include bank leverages (Equity/TA) in our specifications to control for other possible channels through which leverages may directly or indirectly affect securitization, for instance regulatory capital arbitrage. Third, the average standard deviation of equity over total assets for each bank in our sample period is 1.09, indicating time-varying leverage. Therefore, the assumption of persistent leverage does not hold and hence endogeneity bias is less of concern. We are grateful to the referee for raising this point.
Securitizing banks are defined as banks that issues asset-backed securities.
The small sample means of SAR and S A R a d j are primarily driven by the large group of nonsecuritizing banks (4158 banks or 94 % of our sample). The means of SAR and S A R a d j are 7.7 % and 5.9 % for the group of securitizing banks, which are reasonable.
We thank the referee for suggesting this alternative dependent variable.
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Acknowledgments
We are indebted to George Pennacchi and Wolf Wagner for the inspiring discussions. We thank an anonymous referee, Steve Bond, Michael Devereux, Bálint Horváth (discussant), Kebin Ma, José-Luis Peydró and Jing Xing (discussant) for their insightful comments. We too are grateful to participants at the GSS seminar at Tilburg university, 6th International Risk Management Conference, Banking summer school at Barcelona GSE, CBT doctoral meeting 2013 at Oxford University, University of Birmingham, University College London, and 13th FDIC-JFSR Annual Bank Research Conference for their comments. The usual disclaimer applies.
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Jenny E. Ligthart suddenly passed away on November 21, 2012. She was always enthusiastic and tirelessly available to her students, anytime and anywhere. We remember her as an excellent researcher, a professional teacher, a helpful supervisor and a close friend.
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Gong, D., Hu, S. & Ligthart, J.E. Does Corporate Income Taxation Affect Securitization? Evidence from OECD Banks. J Financ Serv Res 48, 193–213 (2015). https://doi.org/10.1007/s10693-014-0210-x
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DOI: https://doi.org/10.1007/s10693-014-0210-x