Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness

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Abstract
Asset-backed securities (ABS) are increasingly becoming an important part of the capital structure decisions of both financial and non-financial firms. In this paper, we focus on a key property of these contracts; namely, that ABS are designed to achieve bankruptcy remoteness of the securitized assets from the borrowing firm. This provides lenders with maximal protection from dilution in bankruptcy that is not available with other contractual forms, such as secured debt. ABS can have real effects in allowing firms to commit to more efficient investment decisions in bankruptcy. We show that securitization of replaceable assets, such as accounts receivable, is particularly valuable in preventing inefficient continuation in bankruptcy, but securitization of necessary assets can lead to inefficient liquidations. In these circumstances, secured debt and/or leases can be preferred because they provide stronger limitations on creditor rights. We provide empirical support for the model by examining the effects on credit spreads in the ABS market following the Chapter 11 bankruptcy of LTV Steel, which cast doubt on the ability to achieve bankruptcy remoteness of securitized assets. Using a difference-in-differences approach, we find that ABS spreads for non-depository securitizers, who are eligible for Chapter 11, increased significantly more than spreads for insured depository (bank) securitizers, who are not Chapter 11-eligible, in the period following the LTV filing. The results demonstrate that the creditor protection provided by bankruptcy remoteness is indeed valuable and priced in financial markets.

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