Sponsor-Underwriter Affiliation and the Performance of Non-Agency Mortgage-Backed Securities

Securitization of mortgage loans involves multiple financial intermediaries. Among them, loan originators, deal sponsors, and security underwriters are the key economic players. Using data on non-agency mortgage-backed securities, we find that i) deals in which underwriters and sponsors are affiliated (vertically integrated) have higher delinquency rates than those in which they are unaffiliated, and ii) the poorer performance of vertical integration is true both when investment banks act as sponsors and when sponsors/lenders act as underwriters. The effect is robust to controlling for security level characteristics, suggesting that the poorer performance is beyond what is observable or priced in the deal. The results are also robust to the inclusion of underwriter fixed effects, suggesting it is the incentive effect that drives the result. In addition, the results are robust to the inclusion of the relation between sponsors and originators. This evidence is inconsistent with the information advantage associated with vertical integration and points to poorer incentives associated with vertical integration. While the literature documents that securitization weakens lenders' screening incentives, our findings suggest that an important factor affecting the performance of mortgage backed securities is the moral hazard on the part of sponsors and underwriters.