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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.

Overview

An 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 an SIV are predominantly (70-80%) Aaa/AAA rated Asset-Backed Securities (ABS) and Mortgage-Backed Securities (MBS) and hence the SIV is effectively providing the funds for mortgages, credit cards, student loans and similar products. An 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 short-term securities that an SIV issues often contain two tiers of liabilities, junior and senior, with a leverage ratio in the range of 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. There may be a mezzanine tranche rated A by rating agencies. 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.

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. To the extent that the SIV invests in fixed assets, hedges are put in place to protect from interest rate risk.

2007 Subprime mortgage 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 SIVs 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 SIVs have already fallen victim to the lack of 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.

In October 2007 a Super SIV bailout fund initiated (but not funded) by the US government was announced (see also Master Liquidity Enhancement Conduit). This plan was abandoned in December 2007. Instead, banks such as Citibank announced they would rescue the SIV's they had sponsored and would bring them on the banks' balance sheet. On February 11th, 2008, Standard Chartered Bank reversed its pledge to support Whistlejacket siv, after recently announcing it would support it. Deloitte and Touche announced that they were appointed as the receiver for the failing fund. Orange County California has $80 million invested in Whistlejack.

Developments in 2008

On January 14, 2008 Victoria Finance defaulted on its maturing commercial paper. The SIV's debt was downgraded to "D" by Standard & Poor's.

Bank of America's fourth quarter earnings for 2007 fell 95% due to SIV investments. . Sun Trust Bank's earnings fell 98% during the same quarter. .

Northern Rock, the first UK bank to have substantial problems due to SIVs in August 2007 was nationalized by the UK government in February 2008. US banks, at the same time 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" . The Fed continued to conduct TAF twice a month to ensure market liquidity. In February 2008, the Fed made an additional $200 million avaialble.

See also

• CDO

References

3. Financial Times, 18Feb2008

External Links

• http://www2.standardandpoors.com/portal/site/sp/en/us/page.article_print/2,1,1,0,1031342466642.html
• http://www.siv0.com/

• Structured finance