About this time last year, all signs indicated that the market for structured investment vehicles (SIVs) was up and coming. In the second half of 2006, the sector had about $250 billion in debt under management. According to Moody's Investors Service, that jumped to $400 billion by a week or so ago. The rating agency estimated that SIV-lites, a less closely managed and slightly simpler version of SIVs, had about $12 billion outstanding by the same date.
Investor demand was strong a year ago and continued through at least early summer, but that has changed dramatically. SIVs operate by investing in highly rated long-term assets and fund themselves by issuing CP and MTNs, aside from a capital component of about 7% or 8%. They depend heavily on the expertise of sophisticated managers to keep their systems running smoothly. More importantly, they use subordination for credit enhancement, thus underscoring the critical market-value component of their structures.
"Depending on whom you speak to, they are essentially market-value CDOs," said one market observer. Now SIVs are suffering from a CDO-like malaise. As CDO investors earnestly questioned the authenticity of anything labeled "highly rated," especially financial instruments that funded U.S. residential mortgages, SIV patrons are waiting for market confidence to restore the viability of the "market value" component of the structures. Either way, normal operations have virtually shut down, and anything being done is being priced at very high levels.
Skepticism about ratings quality is understandable, considering how quickly rating agencies changed their minds about what qualified certain asset-backed securities as highly rated, reworked their rating methodologies and issued downgrades. Such was the case last week, when Moody's' London office announced rating actions on at least a half dozen SIV vehicles, as well as changes to its model for estimating expected losses on their underlying assets.
Standard & Poor's put a ratings watch negative on KKR Pacific Funding, among other actions. Although the program had not breached any triggers, the rating agency noted that it had very low levels of credit enhancement available to cover a loss on the possible sale of securities. The list goes on.
"Moody's has taken certain rating actions as a result of market conditions," the rating agency said last week. "These have not been prompted by any credit problems relating to the assets held by SIVs, but rather reflect the deteriorating market value of SIV portfolios combined with the liquidity crisis. In this scenario, the net asset value of capital is a critical consideration."
For its part, at least by press time, Derivative Fitch had not taken similar measures on the SIV vehicles that it rates.
Just as the U.S. government tossed the subprime RMBS market a confidence booster, in the form of the FHASecure plan, the short-term debt market is now looking to a more traditional sector, in this case banks, to keep it from sliding further. Bank sponsorship might make the difference between normal operations and wind down of much of the SIV market, Moody's said last week.
When they needed to generate billions of dollars in liquidity to make their structures work profitably, SIV managers limited the role of traditional entities in the financial sector. They were confident that they could successfully balance the changing value of the underlying assets with leverage levels needed to generate liquidity to sustain operations. Such an enterprising spirit is fine. But here is a more welcome thought: at least SIV market participants, unlike those in the subprime MBS sector, are calling on the private sector to solve a problem generated by private enterprise. It should stay that way.
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