Corporate Taxes and Securitization

Transcription

1 Corporate Taxes and Securitization The Journal of Finance by JoongHo Han KDI School of Public Policy and Management Kwangwoo Park Korea Advanced Institute of Science and Technology (KAIST) George Pennacchi University of Illinois 1

2 Introduction Until its recent crash, securitization grew tremendously over the last few decades. Securitization has risk management benefits: banks may transfer interest rate and credit risks to investors willing to bear them. But securitization has harmful side effects. Transferring credit risk reduces a bank s incentive to screen the credit of loan applicants and monitor borrowers (Pennacchi, 1988). The current paper emphasizes that securitization may be excessive because it is also motivated by a desire to avoid corporate taxes. Most banks must pay corporate income taxes but special purpose corporations that hold securitized loans do not. 2

3 Contribution of Paper A model is developed to examine the relationship between a bank s loan and deposit market power, its corporate income tax rate, and its incentive to securitize. The model shows that if a bank has profitable lending opportunities but limited deposit market power, then its incentive to securitize increases as its corporate income tax rate rises. Data from Home Mortgage Disclosure Act (HMDA) filings of commercial banks mortgage originations and sales during 2001 to 2008 are used to test the model s predictions. Variation in state corporate income tax rates and MSA demographics allows us to analyze the interaction of taxes, loan and retail deposit opportunities, and loan selling. 3

4 Outline I. A Model of Bank Loan Sales II. Empirical Evidence III. Conclusion 4

5 I. A Model of Bank Loan Sales I.A Assumptions (A1) Each period a bank faces multiple lending opportunities. A one unit loan made to borrower i returns the cash flow of x i (s,a i ) at the end of the period, where s S is the end-of-period state of nature and a i is the bank s initial credit screening/monitoring. (A2) x i (s,a i ) is a weakly increasing and concave function of a i. The bank s screening/monitoring is not verifiable and contractible by outsiders (loan buyers) and its (end-of-period) cost equals c a i. (A3) The bank is subject to a corporate income tax at rateτ and must meet a regulatory minimum equity (E) to deposits (D) ratio. This leverage constraint is given by κd E. 5

6 Assumptions (continued) (A4) p e (s) and p d (s) are initial prices of unit end-of-period payments in state s for securities (personally) taxed as equity and debt. Certainty-equivalent competitive returns to equity and debt are r e and r d, where 1/(1+r i ) S p i (s) for i = e, d. p e (s)/p d (s) is constant across states, equal to (1+r d )/(1+r e ). Also, r d (1-τ) < r e. (A5) The bank can invest in securities that have state-contingent returns and a certainty-equivalent rate of return of r d. (A6) The bank has deposit market power and pays a certaintyequivalent deposit interest rate of r D = r D (D), where r D / D 0. (A7) The bank maximizes the after-tax return to shareholders equity. Deposits are fully insured with the bank paying an insurance premium that fairly reflects its default risk. 6

7 I.B The Bank s Optimization Problem Denote N h (N m ) to be the number of loans that the bank holds (sells or markets) and let B be its investment in securities. h { } N, N, a, B, D, E { m e h N d m ( ) ( ) ( ) ( ) ( ) max h N 1 + r, 1,0 1 m 1 e p s x i S i s ai ds ca i + p s x i 1 S i s ds = = i }( 1 τ ) + rb rd re subject to d D e ( ) ( ) N m h N d m + B D + E + p s x s, 0 i= 1 S i ds 1 financing κ D E capital Let λ f and λ k be the Lagrange multipliers on the financing and capital constraints, respectively. 7

8 I.C Equilibria With No Loan Sales Market (N m =0) I.C.1 Equilibrium with Excess Capital With λ k = 0, the tax-adjusted cost of financing equals λ f rd re = rd + D = 1 τ D 1 τ In this Loan rich, deposit poor equilibrium the bank has many profitable loans which are funded at the margin with excess equity. ( 1 r ) p e( s ) x h ( s, a ) ds 1 ca r /( 1 τ ) h h h + e = S N N N e Deposits are issued up to the point where their marginal cost equals the tax-adjusted cost of equity. It is unprofitable for the bank to hold securities since r d < r e /(1-τ). 8

9 I.C.2 Equilibrium with Binding Capital and Security Investments With λ k > 0, the tax-adjusted cost of financing equals λ f 1 rd κ re = rd + D + 1 τ 1+ κ D 1+ κ 1 τ If it is optimal for the bank to invest in securities, it must have limited lending opportunities but substantial deposit market power. In this Loan poor, deposit rich equilibrium, λ f /(1-τ) = r d and the marginal loan satisfies e h ( ) ( ) ( ) e 1 + r p s x s h, a ds h 1 ca r h = N N N S d 9

10 I.C.3 Equilibrium with Binding Capital and without Security Investments Another equilibrium with λ k > 0 but where the bank holds no securities can be described as Loan and deposit compatibility. In this equilibrium, the marginal cost of financing satisfies λ f re rd 1 τ 1 τ ( ) A special case is a bank that has access to a perfectly elastic supply of competitively-priced brokered or wholesale deposits: λ f 1 κ re = rd + 1 τ 1+ κ 1+ κ 1 τ 10

11 Summary: Equilibria Without Loan Sales Market There are three types of equilibria: 1. There is a Loan rich, deposit poor equilibrium where: Many profitable loans are funded at the margin with excess equity. Deposits are issued to the point where their marginal cost equals the taxadjusted cost of equity. It is unprofitable to invest in securities. 2. There is a Loan and deposit compatibility equilibrium where: Loans are funded at the margin with equity and moderate cost deposits. Capital constraints bind; it is unprofitable to invest in securities. 3. There is a Loan poor, deposit rich equilibrium where: Few profitable loans are originated. Equity and low cost deposits are invested at the margin in securities. Capital constraints bind. 11

12 I.D Equilibria with a Loan Sales Market If loan i is retained on the balance sheet, then a * i satisfies h ( * x ) i s, a e i ( 1+ re ) p ( s) ds = c S * a and the present value of the profit from holding the loan is S * ca 1 / 1 d * i λf p s x s a ds h ( ) (, ) i i i 1+ r d ( τ) + + If, instead, the loan is sold, the present value of profit is m ( ) ( ) p d s x s i,0 ds 1 S 12

13 Excess Profit of Holding versus Selling The excess profit from retaining versus selling the loan is S λ /1 * * f i i i i ( ) (, ) (,0) ( τ) d p s x s a ca x s ds 1+ r The first term (integral) is unambiguously positive. If the bank s equilibrium is Loan poor, deposit rich, so that it invests in securities and λ f /(1-τ) = r d, then the second term equals zero and there is never an incentive to securitize. d r d In this case, a marginal increase in the corporate tax rateτ has no effect on the incentive to sell loans. 13

14 A Potential Loan Selling Equilibrium If the bank s equilibrium is Loan rich, deposit poor, so that it holds no securities and λ f /(1-τ) = r e /(1-τ), then the excess profit of retaining versus selling is d ( ) ( * ( ) ) * re /1 τ r d p s xi s, ai cai xi( s,0) ds S 1+ r Since r e /(1-τ) > r d, the second term is negative, so there could be a net advantage to selling the loan. Importantly, the net advantage to loan selling is an increasing function of the corporate tax rateτ. Similarly, an advantage to loan selling can exist for the Loan and deposit compatibility equilibrium if r d < λ f /(1-τ) r e /(1-τ). d 14

15 Summary: Equilibria With Loan Sales Proposition 1: A Loan poor, deposit rich bank will invest in securities, and a marginal increase in its corporate tax rate has no effect on leverage or its incentive to sell loans. A marginally higher tax rate or equity capital requirement decreases its securities purchased but not the quantity of loans held on its balance sheet. Proposition 2: A Loan rich, deposit poor or Loan and deposit compatibility bank chooses not to invest in securities, and a marginal increase in its corporate tax rate increases its incentive to sell loans and can raise its leverage. A marginal increase in the bank s equity capital requirement also raises its incentive to sell loans. 15

16 II. Empirical Evidence II.A Data The data covers the period and includes: 1. Individual bank s HMDA filings on mortgages originated and sold during each calendar year. 2. Call Report and Summary of Deposits data on C-Corp banks that have at least 90% of their deposits in a single state and a single MSA. 3. State corporate income tax rates for each year from the Tax Foundation 4. Census Bureau projections on each MSA s proportion of seniors (aged 65) for each year. Following Becker JFE 2007, this proxies for an MSA s extent of being loan poor, deposit rich. 5. Other MSA-level data on housing supply elasticity (Saiz (2010)), population growth, personal income growth, and unemployment. The final sample has 12,175 bank-year observations. 16

17 Mortgage Sales Ratio Our main variable of interest is the Mortgage Sales Ratio, MSR: MSR = Value of mortgages that were originated and sold during the year Value of mortgages that were originated during the year We also differentiate between non-jumbo mortgages and jumbo mortgages, since the former may be easier to sell (to GSEs). 17

18 II.B Summary Statistics 18

19 Summary Statistics (Continued) 19

20 II.C Univariate Tests 20

21 II.D Multivariate Tests To test the proposition that higher corporate taxes lead to loan sales at low security banks, we run the following Tobit regression: MSR = a TaxRate + a I TaxRate + a I 1 2 Seniors< Median 3 Seniors< Median + Bank Controls + MSA Controls + Time Effects I Seniors< Median where is an indicator variable that equals 1 if the bank s MSA population has a proportion of seniors (aged 65) below the median. Our model predicts that the sum of the coefficients a 1 and a 2 should be positive. 21

22 Tobit Analysis of Mortgage Sales Ratio 22

23 Analysis of Mortgage Sales Ratio: Robustness 23

24 Tobit Analysis: Senior Population Subsamples 24

25 Fama-MacBeth Regressions: Low Senior Sample 25

26 Regressions of Annual Changes, ΔMSR 26

27 Interpreting the Results The results imply: Higher corporate tax rates have little effect on mortgage sales for banks in high senior loan poor, deposit rich MSAs. A one standard deviation increase in the corporate tax rate (1.88%) increases the mortgage sales of banks in low senior loan rich, deposit poor MSAs by 24.6%. Mortgage sales increase with a bank s size. Non-jumbo mortgages are more likely to be sold and their sales are more sensitive to corporate taxes than are jumbo mortgages. 27

28 III. Conclusions and Policy Implications Corporate taxes lead to greater (excessive?) loan selling for banks with substantial lending, but limited retail deposit, opportunities. This implication most likely extends to larger, multistate banks and non-bank lenders (e.g., finance companies). Reforms to strengthen capital standards and/or deposit insurance may increase the tax incentive to securitize, leading to less credit screening and monitoring by banks. * Similarly, recent proposals to levy new taxes on banks may be counter-productive due to the asymmetric tax treatment of banks versus special purpose corporations. * Higher capital requirements are claimed to cause French banks to begin securitizing. 28 See French Banks Try an Import from U.S. Wall Street Journal Nov. 6, 2012.