structured investment vehicle

A structured investment vehicle (SIV) is an evergreen credit arbitrage fund, similar to a CDO or Conduit. They are usually from around $1bn to $30bn in size and invest in a range of asset-backed securities, as well as some financial corporate bonds. SIV is to make profits from the difference between short term borrowing rate and long term returns. The risk that arises from the transaction is twofold. First of all, the solvency of the SIV may be at risk if the value of investments falls below the equity part. Secondly, there is a liquidity risk, as the SIV borrows short term and invests long term, that is the debt comes due before the asset falls due. Unless the borrower can refinance short-term at favorable rates, he may be forced to sell the asset into a depressed market.

Overview

A SIV can be imagined as a virtual bank. It borrows money using the commercial paper (CP), which it traditionally issues close to the interest rate of LIBOR. It then uses the money to purchase bonds - effectively lending it out much as a bank would provide loans. The bonds usually selected by an SIV are predominantly Asset-Backed Securities (ABS) and hence the SIV is effectively providing the funds for mortgages, credit cards, student loans and similar products. And SIV would typically earn around 0.25% more on the bonds than it has to pay to the CP. This difference represents the profit for the SIV which will be paid to the capital note holders and the investment manager. The capital note holders are the "first loss investors" in that if any of the bonds purchased default, the capital note investor will lose his investment before the CP investors.

Structure

The basic structure has two tiers of liabilities, junior and senior, with a leverage ratio in the region 10 to 15 times. The senior debt is invariably rated AAA/Aaa/AAA and A-1+/P-1/F1 (usually two rating agencies are chosen), while the junior debt may or may not be rated. When it is rated it is usually in the BBB area. The senior debt is a pari passu combination of medium term note (MTN) issuance and commercial paper (CP) issuance. The junior debt is traditionally puttable rolling 10 year bonds, however shorter maturities and bullet notes are becoming more common.

SIVs are floating-floating spread arbitrage vehicles, the profit being the difference between the spread over Libor on the asset bonds, and the (often negative) spread on the funding (senior liabilities). To the extent that the SIV invests in fixed assets, hedges are put in place to protect from interest rate risk.

In order to support the high senior rating, SIVs are also obliged to obtain liquidity facilities (so called back-stop facilities)from banks to partially cover some of the senior issuance. This helps to protect the investors from the risks of market disruption, for example if the SIV is unable to refinance debt coming due in say the CP coming due in the capital markets amongst, other things.

2007 Sub-prime Crisis

Main article: 2007 Subprime mortgage financial crisis

In 2007 the sub-prime crisis caused a widespread liquidity crunch in the CP markets. Given that SIVs rely on short dated CP to fund longer dated assets, there is a constant need to renew funding. In August SIV managers saw CP spreads widen up to 100bp (basis points), and by the start of September the market was almost completely illiquid. The fact that CP investors have been reluctant to invest despite the fact that SIV's contain minimal sub-prime exposure, and as yet have suffered no losses through bad bonds, has highlighted the fear on the CP investor's side. Interpreting this as prudence or lack of understanding and sophistication is a matter of debate.

A number of SIV's have already fallen victim to the liquidity, most notably Cheyne, while others are believed to be receiving support from the sponsoring bank. It is notable that even in "failed" SIVs there have still been no losses to CP investors.

Notable SIV managers

Most SIVs are run or sponsored by banks, however a number are managed independently.

Bank Sponsors

• HSH Nordbank manages Carrera Capital Finance
• Bank of Montreal manages Parkland Finance and Links Finance
• Citigroup manage a number of SIVs including Zela Finance, Beta Finance, Sedna Finance and Dorada Finance
• Dresdner Kleinwort manages K2 Corporation
• HSBC manages Cullinan Finance
• Societe Generale manages Premier Asset Collateralized Entity (PACE)
• Standard Chartered Bank manages Whistlejacket Capital and White Pine Corp
• WestLB manages Harrier Finance

Independents

• Brightwater Capital Management manages Kestrel Funding
• Cheyne Capital Management managed Cheyne Finance
• Eiger Capital Limited manages Orion Finance
• Stanfield Global Strategies manages Stanfield Victoria

Links

http://www.risk.net/public/showPage.html?page=328506

http://www2.standardandpoors.com/portal/site/sp/en/us/page.article_print/2,1,1,0,1031342466642.html

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