Remember SIVs, financial public enemy number one of late 2007? Henry Paulson spent a lot of time failing around trying to come up with a remedy that involved only the government knocking heads together. That was a resoudnig Then it appeared that everyone shrugged their shoulders and decided this wasn’t such a big deal after all.
I’m left mystified on a couple of points:
1. Why these things existed in the first place (as in why they were deemed preferable to securitization)
2. How much of a role they played in the crisis
To point one, I can come up with some advantages, and they don’t strike me as compelling, so clearly I am missing something important. In a securitization, you can created different risk classes, so the “targeting particular investors” argument does not seem a particular advantage UNLESS SIVs appealed to a particular type of investor who was not keen on normal securitizations of bank assets.
To that issue, SIVs did seem to target shorter-lived asset than other securitizations. Or did they? They were funded largely with commercial paper, so was this simply a yield curve arbitrage strategy with a bit more leverage than a normal commercial bank? SIVs were leveraged typically 10-15x, so this does not appear to be driven primarily by the ability to obtain higher gearing (yes, presumably the leverage was higher since drecky SIV assets presumably not as highly geared on balance sheet).
SIV managers also took ongoing fees, but I am not certain how important this factor was in terms of overall economics. An SIV may have been cheaper to set up than an asset backed security.
It would be helpful if anyone could describe or provide a link to the economics from the bank’s perspective of the economics of an SIV versus an ABS to see why and when SIVs were preferable.
To the point #2, SIVs went in, as far as the media was concerned, from a huge issue to a non-issue. Yet the “we need to get rid of the toxic waste on bank balance sheets” theme reflects in part SIV assets presumably taken back on bank balance sheets (ro at least that was the plan as of early 2008).
This was a $400 billion market at its peak. Citi was the biggest player, and UBS and apparently Merrill were involved in a meaningful way. Does anyone know, ex Citi, if SIV paper caused meaningful indigestion at any big bank?
Thanks! Anyone not set up to comment feel free to ping me at yves@nakedcapitalism.com
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A SIV was half way between a securitization which has a fairly fixed pool of assets/ fixed financing structure and a commercial bank.
Banks used SIVs as another way to play the yield curve. They borrowed in the CP mkt with the bank's credit rating and invested in ABS out the curve. SIVs were the method used to take advantage of the the then ubiquitous view of negligible risk associated with cash flow timing mismatches.
Yves, there was an excellent write-up on SIVs that was part of story on Gordian Knot Ltd. (a London hedge fund) that came out when MLEC was the topic of conversation.
The Wheelman,
Thanks, but I was following SIVs intently at the time and read all the MSM stuff and a good deal of additional stuff on the Web I am looking for info about the economics of the vehicles themselves (as to why dealers saw this as more attractive than a traditional securitization, and any sense of what the eventual losses turned out to be).
Now having said, that, there may well be subsequent research or material posted that I missed.
Yves… the biggest difference is that a securitization is a static pool whereas an SIV is actively managed. That brings advantages and disadvantages. The advantages include the savings on cost (i.e., only one structure has to be set up and then can be used to cycle the arb continuously) and the ability to, like you point out, make a play on the yield curve (i.e., the SIV funds its long term assets with short term liabilities). The main disadvantage is the duration mismatch and in times of stress the inability to roll the liabilities at some rate less than that paid by the assets. In many ways, an SIV works very much like a bank… but as you say it is off balance sheet. Where your understanding I think misses the point is in your concept of leverage. The aggressive structure in Europe were levered closer to 25:1 or 30:1… hence the reasons banks like Citi moved into the market. This concept of ultra high leverage was supported structurally in that SIVs were typically only allowed to invest in AAA-rated, <2 yr WAL, floating rate securitized assets. Unfortunately, once the bid for these assets dropped below par on true credit concerns the game was up.
You also are way too generous in: a) your assumption that this problem has been resolved by the banks in question bringing the assets back on balance sheet; and b) that the market was only $400B in size. At its peak, Citi was running very close to $1T of SIVs all by itself! What *could* be brought back on balance sheet was (i.e., the least levered SIVs backed by the best assets), but the dreck is still in limbo. Whatever the new FASB rule that takes effect on 1/1/10 that requires these finally be consolidated will be particularly painful to Citi… though on the plus side, they'll be the largest bank in the country again. The issues are: a) these are the SIVs that were backed by subprime floaters that are still $50-00 bid (because they're floaters at 1mL+3bps and will without question take significant credit losses); and b) adding them back onto C's balance sheet with essentially no equity coming along for the ride will again decimate C's capitalization ratios.
Contrary to your suspicions, this is actually part of the mine field that UBS avoided. Apart from Citi, the big culprits were the Anglo/Irish major banks. Fortis and Dexia too.
Hope this helps,
Entirely already did a great job summarizing it, so let me just add a couple of points.
The first one is that SIVs make sense from the issuer's perspective, not from the buyer's perspective. When they were rolled out, the buy side was totally insensitive to risk, and would take virtually anything with a favorable yield; and SIVs had a favorable yield, although only just barely (in retrospect, a comically low yield relative to their real risk.)
From the issuer's side, SIVs were fantastic in that they were off-balance sheet, and therefore could be used to unload all kinds of securities. Some may have had restrictions on holding only AAA securities, but many of those were themselves structured products built on B- garbage. Banks could push all kinds of stuff into the SIVs either directly or indirectly, which helped make a lot of deals happen, as there was now a ready buyer, provided it was structured correctly.
SIVs were able to get funding because their liabilities were very short-term, so the ratings agencies gave them relatively favorable ratings, despite the toxic waste lurking one or two layers down. The general mindset was that nothing could go wrong in 90 or 180 days, so as long as the funding was short-term, any problems could be seen well in advance, and the paper issued by the SIVs was therefore safe. That made much of their financing money market fund eligible; and given the massive buying power of the MMFs, that was enough to allow the SIVs to expand to huge sizes on massive leverage.
The point about the SIVs basically being banks is a very insightful one–making money off the yield curve and a perceived risk differential. The difference, of course, is that SIVs had nothing resembling competent management, and virtually no oversight or regulation.
Entirely,
This was very helpful, thanks, But it raises other questions:
The WSJ regularly reported that the total size of the SIV market was $400 billion, and they were clearly in direct contact with the Treasury. The WSJ also reported on how much Citi had in SIV exposures, and how much it had whittled them down, see here
http://www.nakedcapitalism.com/2007/10/siv-bailout-plan-does-math-work-even.html
for one of many examples then. Citi has $100 billion of SIVs, this reported regularly, WSJ also reporting on Citi's progress in selling SIV assets.
Now I have seen plenty of mistakes in MSM reporting, but that MLEC story was front page news for about two months. Rating agencies are all over this paper. If the market was as much larger as you suggest, someone would have pointed out the error, if nothing else in the blogopshere, I never saw anyone say the market was bigger.
CIti's TOTAL off balance sheet exposures now are $1 trillion. I can't imagine that is all SIVs, all one structure.
I was told directly by a buyer of UBS paper that UBS was big in the market (which if true was not reported), due to UBS imitating Citi.
I saw this, not sure how helpful it is:
http://uk.reuters.com/article/idUKL1533252420071015
I see a couple of failed SIVs on the list (Whistlejacket and Cheyne)
This post by Gwen Robinson at FT Alphaville from October 2008, Sigma collapse marks end of SIV era, mentions the $400 billion figure.
"Sigma Finance, the last of the complex debt funds at the heart of the credit crisis has collapsed and is to appoint receivers, ending a 25-year project to create a “shadow banking” industry…. Sigma, a $27bn structured investment vehicle managed by UK-based Gordian Knot, is the last surviving member of a once $400bn industry crushed by declining asset values and lack of new funding."
Would being evergreen structures that generated compensation for investment managers and were based in tax havens such as the Caymans or Jersey distinguish SIVs as a way of moving loans off balance sheets?
As someone who aspires to the level of hobbyist when it comes to finance, one simplistic assumption I sometimes employ to make sense of the current mess is that demand for AAA-rated USD-denominated assets outran supply generated by conventional methods. (Thus, say, if Cheney's energy task force had decided to create a "Manhattan Project" to reduce US demand for fossil fuels and fund it by selling Treasury debt, the US financial sector would have had that much less incentive to mess with residential real estate in order to satisfy demand.)
It seems the SIVs were a means of generating a certain quality of CP which was bought largely by money market funds? What was SIV CP competing against? And the role of the SIVs in terms of off-loading assets and generating CP needs to be evaluated over time; the incentives for creating an innovative product may be quite different from the incentives for making use of it in later days.
Several German banks, including IKB, and the landesbanken in Saxony were active in SIVs, too. It is incredible that regulators did not require much capital charge for banks' contingent liquidity lines to these SIVs. The funding for SIVs was about half commercial paper and half medium term notes (MTN). They buy about half structured finance transactions and half highly-rated senior bank papers.
Yves
thank you for bringing this topic up, I personally think it is deserving a lot more attention than it is getting due to the size these programs had.
Thus, I wanted to touch on the size of this market. I agree with Entirely that Citi alone accounted for more than $400MM, since I was on a buy side in 2007 and actually worked with the bank on a deal regarding one of their conduits.
regarding WSJ article, there actually could be confusion regarding what is meant by an SIV. (BTW, by SIV I usually mean Special Inv Vehicle, not Structured one.)
I am sure ABCP conduit can be classified as an SIV in the sense of your piece. How about auction rate SIV? Many Canadian banks had SIVs that were funded by nothing but senior CDO tranches (first corporate, then ABS), but not by CP collateral.
I believe the SIV market size ran into trillions ($2-$4 trillion), and now this huge source of liquidity is gone. Plus, as you mentioned, the banks are bringing them back on balance now. So it is a big deal, and I am happy you are covering it.
Do you have an access to Citi's research web-site? They published a piece on this market earlier in the year. Unfortunately, it is passworded, so I can not provide a link.
Slim,
Thanks for the interest and lead. Yes, there does seem to be a big nomenclature issue, with SIV referring to a particular structure in a much bigger category.
One thing that appears to be true of SIVs that may not be true of other conduits is that they owned a lot of bank liabilities, mainly floating rate notes, but perhaps also trust preferred securities. That would make them leverage on leverage vehicles.
Yves,
You may wish to check out Traders, Guns and Money by Satyajit Das. Pages 231-234 and 282-286 cover quite a few reasons why they existed but as it was published in 2006 it won't tell you how big of a role in the crisis these structures played.
Some examples:
A) They begin innocuously enough by changing floating rate debt into fixed rate, so just a repackaging similar to STRIPS
B) they are unrelated to the investment bank, so if the bank goes under the investment is unaffected
C) Unregulated and off the balance sheets of the banks
D) Then by accident, banks found out they could use CDS in these structures. Before you would have to get agreement from borrower to sell off a loan. JPM instead entered a CDS with its SPV, the loans stayed on its books, the risk was transferred. The SPV raised money and bought Govt issues. This was cheap and employed tons of leverage. Banks got a bit more of C
E) Did not cost them capital, so their ROEs would be higher
Good luck with the book
Slim,
I do have someone who can run it down, but he needs more detail, such as date range or author or title/partial title or dept.
Thanks!
Unless you understand why SIVs existed you'll never be able to deconstruct them. SIVs were designed as a way to solve a very real problem for small and medium sized banks — and they had little to do with the assets or the ABCP.
Largely because of securitization, the market was being disintermediated in the period after 1985. At the same time, many Eurorpean banks were losing their relationship management arrangements (think small German bank and Deutsche Bank circa 1980)and many state owned institutions were being spun off. This meant a host of problems:
1. Each bank needed to manage its own treasury operation;
2. An increasing amount of high-grade paper in which they may have wanted to invest was in the form of securitization and therefore slightly complicated;
3. Each of these banks would have needed to hire a team of analysts and develop systems to allow them to invest in these assets and arguably there weren't enough to go around;
4. Their own credit ratings meant that their cost of funds was often greater than the spread available on assets;
5. All combined, these problems meant that each such back had to hire and expensive team and probably move down the rsk spectrum.
As originally conceived, a SIV addresed these problems by:
1. Allowing investors to pool their money and rent the services of an experienced team to pick, analyze and manage their assets;
2. Solving the cost of funds issue by allowing for the investment in the highest grade assets and applying what was seen as moderate leverage against them rather than increasing the risk by investing in higher yielding assets.
That it ultimately didn't work is obvious, but it's still important to know why they existed in the first place. They were never securitizations and originally had nothing to do with either unloading assets or with the issuance of ABCP. SIVs simply borrowed securitization technology in order to address a real problem in the market.
Arguably, once the structure was understood it was copied by people who couldn't care less about why it existed and this led to all sorts of problems, but to understand why the world ended up with SIVs you've got to look at them from the other end. They were designed as money management tools for treasury operations of banks who lacked the resourses to do the job themselves. The holders of the Capital Notes (the sub-debt) were the key to everything and the fact that they came to be seen as high-end CDOs is the reason why markets go bad.
Is there any kind of visual representation out there, which incorporates the information above.
One very important thing to realise about SIVs is how they differ from ABCP conduits – the difference is key to their rise.
ABCP conduits generally need full committed liquidity support from a highly rated bank. This has a capital cost – indeed, under Basel II, it's effectively the same cost as if the assets were on balance sheet. SIVs, by contrast, had very little committed liquidity (there's a dynamic formula based on maximum outgoings over given periods, but it worked out to around 5% of total liabilities in most cases). This made them a lot more "capital efficient" than securities arbitrage conduits and also meant that small banks like IKB could manage very large portfolios of assets, earning fees in the process. And because the CP market was so large and liquid (because money market funds were desperate for yieldy paper), it was relatively easy to ramp up a SIV portfolio in a short period of time. We're talking $20bn in 6 months in some cases, although it became harder in the last years of the boom.
"2. How much of a role they played in the crisis"
A pretty huge one, early on. In Europe, they became more than half of the AAA investor base, and the most recently created SIVs were huge buyers of late vintage subprime RMBS, facilitating the disastrous 06/07 vintage lending. When ABCP liquidity dried up in July/August 07, suddenly the greater part of the ABS investor base was out of action, causing spreads to widen on ABS that at the time was not under any threat of credit losses. This lead to writedowns, and a lack of discrimination between "toxic" and other securitisations. When it became obvious the market for SIVs wasn't coming back, spreads on bank debt and ABS ballooned out massively as people anticipated liquidations. By this point, it was uneconomical or impossible to securitise in any volume for most issuers, which caused major funding problems for many banks, on top of the higher cost of their unsecured and especially subordinated debt.
That pretty much takes us to the Lehman collapse, at which point the importance of the SIVs began to fade as wider issues became more pressing.