Structured investment vehicle
From Wikipedia, the free encyclopedia
A structured investment vehicle (SIV) is a fund which borrows money by issuing short-term securities at low interest and then lends that money by buying long-term securities at higher interest, making a profit for investors from the difference. SIVs are a type of structured credit product; they are usually from $1bn to $30bn in size and invest in a range of asset-backed securities, as well as some financial corporate bonds. A SIV has an open-ended (or evergreen) structure; it plans to stay in business indefinitely by buying new assets as the old ones mature, and the SIV manager is allowed to exchange investments without providing investors transparency / the ability to look through to the structure.
The risk that arises from the transaction is twofold. First, the solvency of the SIV may be at risk if the value of the long-term security that the SIV has bought falls below that of the short-term securities that the SIV has sold. Second, there is a liquidity risk, as the SIV borrows short term and invests long term; i.e., outpayments become due before the inpayments are due. Unless the borrower can refinance short-term at favorable rates, he may be forced to sell the asset into a depressed market.
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[edit] Overview
A SIV may be thought of as a virtual bank. It borrows money using 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 a SIV are predominantly (70-80%) Aaa/AAA rated Asset-Backed Securities (ABS) and Mortgage-Backed Securities (MBS) -- hence the SIV is effectively providing funds for mortgages, credit cards, student loans and similar products. An SIV would typically earn around 0.25% more on the bonds than it pays on the CP. This difference represents the profit that the SIV will pay 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 do.
[edit] Structure
The short-term securities that a SIV issues often contain two tiers of liabilities, junior and senior, with a leverage ratio ranging from 10 to 15. The senior debt is invariably rated AAA/Aaa/AAA and A-1+/P-1/F1 (usually by two rating agencies). The junior debt may or may not be rated, but when rated it is usually in the BBB area. There may be a mezzanine tranche rated A. The senior debt is a pari passu combination of medium-term notes (MTN) and commercial paper (CP). The junior debt traditionally comprises puttable, rolling 10-year bonds, but shorter maturities and bullet notes are becoming more common.
In order to support their high senior ratings, SIVs are also obliged to obtain liquidity facilities (so-called back-stop facilities) from banks to cover some of the senior issuance. This helps to reduce investor exposure to market disruptions that might prevent the SIV from refinancing its CP debt. To the extent that the SIV invests in fixed assets, it hedges against interest-rate risk.
[edit] 2007 Subprime mortgage crisis
In 2007, the sub-prime crisis caused a widespread liquidity crunch in the CP market. Because SIVs rely on short-dated CP to fund longer-dated assets, they are frequently refinancing. In August, CP spreads widened to as much as 100bp (basis points), and by the start of September the market was almost completely illiquid. That showed how risk-averse CP investors had become even though SIVs contain minimal sub-prime exposure and as yet had suffered no losses through bad bonds. It's a matter of debate, however, whether this risk aversion was a matter of prudence or misunderstanding of the CP market.
Several SIVs -- most notably Cheyne -- have fallen victim to the liquidity crisis. Others are believed to be receiving support from their sponsoring banks. It is notable that even among "failed" SIVs there have still been no losses to CP investors.
In October 2007 the U.S. government announced that it would initiate (but not fund) a Super SIV bailout fund (see also Master Liquidity Enhancement Conduit). This plan was abandoned in December 2007. Instead, banks such as Citibank announced they would rescue the SIVs they had sponsored and would bring them onto the banks' balance sheets. On Feb. 11, 2008, Standard Chartered Bank reversed its pledge to support the Whistlejacket SIV. Deloitte & Touche announced that it had been appointed receiver for the failing fund. Orange County, California., has $80 million invested in Whistlejacket.
[edit] Developments in 2008
On Jan. 14, 2008, SIV Victoria Finance defaulted on its maturing CP. Standard & Poor's downrated debt to "D".
Bank of America's fourth-quarter 2007 earnings fell 95% due to SIV investments. [1]. Sun Trust Bank's earnings fell 98% during the same quarter.[2] .
Northern Rock, which in August 2007 became the first UK bank to have substantial problems stemming from SIVs, was nationalized by the British government in February 2008. At the same time, U.S. banks began borrowing extensively from the Term Auction Facility (TAF), a special arrangement set up by the Federal Reserve Bank in December 2007 to help ease the credit crunch. It is reported that the banks have borrowed nearly $50 billion of one-month funds collateralized by "garbage collateral nobody else wants to take" [3]. The Fed continued to conduct the TAF twice a month to ensure market liquidity. In February 2008, the Fed made an additional $200 billion available.
