Evidence of Income Smoothing from Securitized Loans and Loan Loss Provisions: Real Transactions vs. Accruals

The purpose of this study is to investigate the relationship between the use of securitized loans and loan loss provisions. As the development of financial asset securitizations (securitizations) is increasing in banking industry, loan transfers under control-and-financial-components approach prescribed by Statement of Financial Accounting Standards (SFAS) No. 140 (FASB 2000) have become available for mangers to smooth income. However, banks have to face negative consequences from real transactions of securitizations. To achieve smoothing objective, loan loss provisions, as the largest accruals in banking industry, may have been used by managers strategically with securitizations. This study provides evidence on the complementary relationship between securitizations and loan loss provisions and contributes to the line of earnings management research in identifying a specific real transaction, securitizations, available for banks to manage earnings. In addition, findings of this study have implications for the quality of financial reporting under fair value accounting. The use of real transactions to meet earnings target through volume and gains of securitizations raises issues on the quality of accounting earnings as financial instruments are measured at fair value. Attention should be called to unreliable estimates arising from fair value measurements.