The Relationship between Issuance Spreads and Credit Performance of Structured Finance Securities

This paper analyzes the relationship between structured finance par coupon spreads at issuance and the securities' credit performance. Using structured finance securities including asset-backed and mortgage-backed securities and collateralized debt obligations issued in the U.S. during 1998-2004, we find spreads vary substantially by rating, over time, and across asset classes; the spreads on structured finance securities are correlated with, and generally wider than, those on similarly rated corporate securities. Highly rated securities such as those rated Aaa are more sensitive to systematic risk factors than more lowly rated ones such as those rated Baa. In addition, new issue spreads widen after downgrade rates rise on previously issued securities, and securities with wider spreads at issuance (conditional on asset class, rating, and general credit market conditions) are more likely to experience subsequent rating downgrades than other securities.