More on Puzzling Out the SIV Bailout Proposal

I’m late to a very useful tidbit on the structured investment vehicle front, and will also provide an update on the continuing skepticism regarding the proposed rescue plan, the Master Liquidity Enhancement Conduit, the MLEC (aka The Entity).

The Financial Times via its Alphville blog, provided a chart and some commentary on SIVs from the rating agency Fitch which give a rough idea of how the funds are faring:

Net Asset Value, or NAV, is a measure of the amount by which the market value of a SIVs portfolio exceeds the senior debt, divided by the capital – in other words, a measure of a SIVs underlying worth after leverage.

Not only does Fitch’s graph highlight that SIV’s fortunes have steadily worsened, it also points to a growing divide. Some SIVs are in a far worse NAV situation than others. Axon Financial, managed by TPC-Axon Capital Management, has a NAV currently at 35-40 per cent. Compare to AbAcAs Investments, managed by EBI/NSM. Its net asset value (NAV) is at around 100-105 per cent.

Even if funding briefly loosened up after August, SIV NAVs are still clearly troubled.

Citi – the prime mover behind M-LEC, is a case in point. While the bank could last week declare it had funding for all its SIV CP for the next year, it couldn’t rest on its laurels: The 3 Citi SIVs Fitch rates (in total there are 7) have seen NAVs slide pretty much in line with Fitch’s graph. On September 6, Beta’s NAV was 85.3 per cent, Five’s NAV was 81.6 per cent and Sedna’s NAV was 81 per cent. One month later, on October 8, Fitch puts Beta at 75-80 per cent, Five at 70-75 per cent and Sedna at 75-80 per cent. A decline of up to 10 per cent.

M-LEC is not only about restoring confidence and making the market more transparent. It’s about restoring asset values.

Felix Salmon at made a further observation about the Fitch data:

There’s three scary things here. The first is that Fitch doesn’t know what the NAVs of the SIVs it rates are with any more accuracy than a five-percentage-point range. The second is that Citi’s SIVs are have NAVs as low as 70 cents on the dollar. And the third is that they suffered a big drop in NAV in September, after the market turmoil of August.

Now to the various updates. The Fed has been pressured, no doubt by the Treasury, out of its normal reserve to say positive things about the MLEC.

Am I missing something? Just a short while ago, it was conventional wisdom among faithful capitalists that the government didn’t know its ass from its elbow as far as markets or commerce was concerned, and it therefore should keep its bloody nose out of such matters. But now that markets look a bit wobbly, these same captains of free enterprise seem desperate to have an endorsement from Public Authorities (well, at least the ones with deep pockets).

From the Wall Street Journal, “Fed Says Its Silence on SuperSIV Does Not Reflect Opposition“:
A senior Federal Reserve official said the central bank’s silence on the Master-Liquidity Enhancement Conduit — or super SIV —

has been “misconstrued” as opposition or lack of support for the proposal.

“The silence has been misconstrued,” the official said. “The proposal looks reasonably well designed and has the potential to contribute — rather than to impair — improvements in these markets and the process of price discovery.”

But as the Financial Times reports, the drumbeat of doubt about the MLEC continues. The article notes that Citigroup’s Tier 1 capital has fallen and SIV losses have played a part:

“You can’t bail out anything with a siv,” goes the gag at Citigroup, where executives are exasperated by suggestions that the plan for a $75bn mortgage securities “supersiv” represents some sort of bail-out for the bank….

Citi is the most exposed of all the big banks to SIVs, managing vehicles with about $80bn of assets. “Citi has made a lot of money over the years from these things and now they are asking us to come and help them out,” says one banker.

In an apparent reference to Citi, Jamie Dimon, chief executive of JPMorgan, said last week that there may be “asymmetric benefits” for the various parties involved in the plan.

Citi strenuously denies that its own SIVs are a problem. Since July, Citi has been “executing an orderly process” to fund the SIVs. More than $20bn of assets have been sold from the seven SIVs run by Citi Alternative Investments and it says that about 98 per cent of the assets are now fully funded until the end of the year.

“Citi has seen the market for third-party funding improve recently, with the SIVs raising more than $1.5bn of commercial paper funding from third-party sources in the last week,” it said in a statement.

It adds that the assets are of very high quality with no direct exposure to US subprime mortgages. “The SIVs have approximately $70m of indirect exposure to subprime assets through securities such as collateralised debt obligations. Those securities are AAA-rated and carry credit enhancements.” Citi does not own any of the SIVs’ equity capital which would be most exposed to further deterioration in asset values.

The proposed superfund would be helpful, but only “on the margin”, Gary Crittenden, Citi’s chief financial officer, said last week. But sceptics point to the impact the SIVs are already having on Citi’s balance sheet.

Citi disclosed last week that it had been buying commercial paper from some of the SIVs and that this was one of the reasons that its balance sheet had deteriorated. Its Tier 1 capital ratio fell from 7.9 per cent to 7.4 per cent during the course of the third quarter, falling below its target of 7.5 per cent. A year ago it was 8.6 per cent.

Gary Crittenden, chief financial officer, said the decline was partly due to acquisitions, but also reflected the impact of assets taken on the balance sheet as a result of the credit squeeze, including commercial paper. He said it would continue to provide liquidity to the SIV on an arm’s length basis on commercial terms consistent with those provided by unaffiliated third parties. Citi has suspended share buybacks until its ratios return to more normal levels, expected early next year.

Some conspiracy theorists suggest that the US authorities are concerned that Citi’s exposure to the SIVs could restrict its ability to make new loans. But there are no signs that US banking regulators have any special concerns about Citi, other than the general worries about all banks’ appetite for lending in the interbank market. Citi executives point to significant new loan commitments in recent weeks and insist that it has huge potential lending capacity currently tied up in its securities trading business.

Citi has no contractual obligation to provide liquidity facilities or guarantees to any of the SIVs and says it will not consolidate the assets onto its balance sheet. But most observers believe it would not allow any of the SIVs to fail for reputational reasons. However, senior executives at other banks believe it could take on the assets without creating problems in terms of its regulatory capital, though that would expose it to the risk of another lurch down in US mortgage-backed securities.

However much Citi insists that it does not need the superfund, other banks have said they would be reluctant to contribute to a plan that would benefit Citi disproportionately.

But some have been mollified by indications from the lead banks that Citi would provide as much as a quarter of the financing of the superfund. Said one banker: “As long as they provide the lion’s share of the funding, we would consider supporting it.”

The phrase “conspiracy theorists” is unwarranted. Early on, Paulson had said his reason for getting involved was that SIV-related losses would reduce bank lending, slowing the economy. Since Citi is a major focus of this exercise, this statement must logically apply to Citi.

By contrast, the blog Accrued Interest argues that the real reason for the rescue is to protect money market funds:

However, the SIV problem is potentially a space-station sized issue. Citi is the headliner here, but even their supposedly $80 billion in SIV sponsorship can’t possibly amount to insolvency. However, something is amiss. The MLEC idea seems like a solution to a non-existent problem, and doesn’t seem to solve any actual problems. Just makes me wonder what the banks know that we don’t know. I’m beginning to suspect that we’re digging in the wrong place by looking at losses within the SIVs. Maybe the real problem is with bank money market funds. Banks don’t want to ever ever ever break the buck. Remember, most banking services are commodities to consumers. If consumers lose even a small amount on their money market fund, the bank can kiss that relationship good bye. And yet, banks legally have a hard time making up for losses within a money market fund out of their own pocket. Has to do with recourse. Anyway, maybe the MLEC is designed to prevent defaults on CP held by bank money markets, in essence by passing the risk on from the money market fund to the bank itself.

I don’t subscribe to this view, but the structure of the deal (if and when announced) will give more insight into what the priorities are.

Finally, SIVs have claimed a new victim, namely King County, Washington:

A county in Washington state emerged as the most recent casualty from the financial-market turmoil caused by complex securities known as SIVs when Standard & Poor’s Corp. said yesterday it may downgrade debt of King County because of investments in debt issued by SIVs….

The rating action by S&P stemmed from investments made by the $4.1 billion King County Investment Pool in three struggling SIVs, which currently total about 3.8% of the fund. S&P said the fund held securities issued by Cheyne Finance LLC, Rhinebridge LLC and Mainsail II LLC. King County includes the city of Seattle.

Ken Guy, King County’s finance director, said county officials saw the SIV-issued commercial paper as a safe investment that would provide slightly higher yields than U.S. government bonds, and relied on the high ratings given the commercial-paper investment vehicles by S&P, a division of McGraw-Hill Cos., and Moody’s Investors Service, a subsidiary of Moody’s Corp.

“That is the frustrating aspect about all this: you have these highly rated investments that have been downgraded simply overnight,” he said. “If you look historically at commercial paper, it’s always been considered a safe investment. This was an area where you might be able to earn a little bit more within safe parameters.”

In August, about $1 billion of the King County Investment Pool’s $4.1 billion in assets was in commercial paper. After commercial paper began taking a beating in the market, the county stopped buying it; now less than 10% of the pool is in commercial paper, Mr. Guy said.

All of the $608 million in commercial paper that the county redeemed in recent weeks paid off at par value, Mr. Guy said. It is unclear, he said, whether the county will lose money on the outstanding commercial paper, including the Cheyne, Rhinebridge and Mainsail investments. If S&P does downgrade the investment pool’s rating, Mr. Guy said, it is unlikely that would affect the county’s ability to borrow money cheaply. The credit ratings on the county’s investment pool and debt service aren’t linked, he said.

King County’s investments were in some of the riskiest or newest SIV structures in the market. Rhinebridge PLC and U.S. counterpart Rhinebridge LLC, for example, began operating as SIVs just this year in an attempt by German bank IKB Deutsche Industriebank AG to broaden its structured-investment business. IKB itself ran into financial troubles in late July when another bank affiliate, a conduit called Rhineland Funding Capital Corp., began having troubles paying off maturing debt.

King County also invested in a risky form of SIVs known as SIV-lites that typically invest more than SIVs in securities tied to residential-mortgage securities, including subprime loans. One investment by King County was in SIV-lite Mainsail II, an affiliate of London hedge fund Solent Capital Partners LLP. King County’s investments have been under stress for several months. In August, S&P downgraded notes issued by Mainsail II.

Print Friendly, PDF & Email


  1. westwest888

    I think I figured out what is going on this morning on my way to work. Bear with me.

    Banks are involved in SIVs to make money; namely they buy asset backed paper (CDO’s) on a long horizon and issue commercial paper on a short horizon, then pocket the difference. The CDO’s pay a higher rate and until recently had a stable NAV.

    The Fed’s job is to make sure the banking system is stable. By lowering rates, they make sure the $400B in SIV bets banks made aren’t out of the money. Because if short term rates goes higher than the long term rates locked in on those CDO investments, the whole thing is a money loser.

    The credit markets froze because nobody wanted to lend short term money to a bank that might give it to a SIV that was about to blow up.

    The M-LEC super SIV might be a plan to lock as much capital in as possible for as long as possible at the Fed’s currently low rates, because they might not stay low forever. At the same time, they’ll buy up all the distressed CDO’s they can. The lower the NAV, the higher the yield on that toxic waste.

    Two lessons: banks always make money; and the Fed isn’t going to let $400B go out of the money.

  2. Yves Smith

    One issue is that the banks don’t have to rescue the SIVs. They are off balance sheet, the equity in them in so low as to be close to non-existent (and should have been written off already for those SIVs that are in trouble).

    So why are the banks so keen to rescue them? It’s not about the SIVs per se but fear of collateral damage, the knock-on effects of the assets of SIVs being sold at fire-sale prices because too many assets come on the market at once. Most people have focused on the impact if players like investment banks have to mark similar assets to market. They may have some similar unsold inventory, but the bigger impact is likely to be that they will mark down the price of collateral against which they have made margin loans, which will lead to margin calls and probably forced selling.

    The other collateral damage scenario is the one from Accrued Interest: that the focus of worry may instead by money market funds. Forced sales from some SIVs would put the value of other SIVS in even greater doubt, and if a money market fund had too much exposure to similar paper, it might “break the buck.”

Comments are closed.