About a month ago, amid the turmoil that caused about $80 billion in securities to evaporate from the structured investment vehicle (SIV) market, Moody's Investor's Service suggested that bank sponsorship might make the difference between normal operations and the wind down of much of that market.
Based on recent news about the launch of the Master Liquidity Enhancement Conduit (M-LEC), the U.S. Treasury Secretary Henry Paulson was already hard at work on such a plan. While much of the asset-backed commercial paper (ABCP) and SIV markets welcomes the idea of fresh liquidity from a syndicate led by Citigroup, Bank of America and JPMorgan Chase, market sources raise several questions as to how it will all work and whether it will effectively steady the SIV market.
At press time, about $80 billion was pledged to the fund, matching the amount of securities that evaporated from the market, making it clear to some market observers that the fund was created so that certain SIVs could pass their liquidity tests.
The M-LEC will finance the purchase of these assets with medium-term notes and commercial paper issuance. The hope is that investors will view the M-LEC as a more preferred issuer than the SIVs themselves and return to the CP market, according to analysts at CreditSights, an independent securities research firm.
Hold on. The whole reason that the delicately balanced SIV market lost its footing, and so much market value, was that many investors did not understand exactly what types of assets were underpinning the securities they held. Investors had grown suspicious of the quality of the underlying paper in SIVs, so they refused to recommit themselves to the programs by rolling new MTNs or CP.
"Say I was running a SIV that had a double-A asset, and it got downgraded. Now its single-A or even triple-B," said one market source. "Do they really want to take that asset?"
Worse still is the possibility that those existing SIV assets performing poorly would degrade even further. CreditSights, among other market observers, has aired concerns about the likelihood that non-subprime RMBS deals could see downgrades.
"The fact that SIVs are diversified outside of RMBS is not necessarily a guarantee that downgrades might not catch up to their non-RMBS assets," the company says. "A significant drop in the weighted average credit rating of their assets would breach minimum credit quality levels, which could in turn lead to forced liquidation of those already deteriorating assets."
Most market sources think that the new fund might choose to provide liquidity only to the most attractive ABS assets of the SIVs. That means the M-LEC bid would likely help familiar triple-A rated assets secured by credit cards, auto and trade receivables. Other SIVs would be left with what CreditSights calls the more toxic, less attractive paper.
It is still unclear whether the so-called super conduit will actually buy MTN and ABCP assets from SIVs that are the worst performing, therefore the purpose of setting up the conduit is equally foggy. Investors clearly wanted a way out of their situations when they refused to roll new paper in some of these vehicles.
As the market awaits more details on how the M-LEC will work, and as it hopes that the severe downgrades have stopped, the real question becomes: Who is going to absorb the losses?
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