Wednesday, August 29, 2007

Five facts about structured investment vehicles

Structured investment vehicles (SIVs) are the latest investment entities to be hit by the double whammy of declining asset prices and squeezed short-term funding.

On Wednesday, Cheyne Finance, an SIV managed by British hedge fund Cheyne Capital Management, said it was seeking to restructure after it was forced to start selling assets to pay down debt. On Tuesday, Rhinebridge Plc, an SIV managed by Germany's IKB, said it had sold assets and did not expect further liquidity support from IKB or its owners. Following are some facts about SIVs:


SIVs issue commercial paper, medium-term notes and capital and invest the proceeds in a portfolio of diversified assets, aiming to generate returns from the spread between the yield on the portfolio and the cost of funding.


The first SIV was Alpha Finance Corporation, launched by Citibank in 1988. Since then a host of specialised asset managers and banks have set up SIVs. As of July, Moody's Investors Service rated 36 SIVs or SIV hybrids managing assets of $395 billion.


SIVs achieve very high ratings for senior debt, typically at the triple-A level for long-term debt and Prime-1 or A-1+ for short-term debt, in order to benefit from low funding costs; they then invest in a range of mostly investment-grade securities. To do so they are bound by a set of limits on the assets they invest in and their liquidity; there are also tests on the value of the portfolios; and SIVs must report regularly -- at least weekly -- to the ratings agencies.


According to Moody's, as of the end of March the average SIV portfolio was 57.5 percent structured finance, 41 percent financial-sector debt, with the remainder made up of corporate and government securities. Of the exposure, 62.4 percent was Aaa rated, 27.9 percent double-A rated, 8.9 percent single-A rated and just 0.2 percent in the Baa or Ba categories.


If an SIV breaches its major capital loss test, defaults on its debt or becomes insolvent, it enters a mandatory wind-down process whereby assets are sold to pay down debt. SIVs typically have a partial liquidity facility to help achieve an orderly sale process, with cash drawn down to cover near-term liabilities.

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