Structured investment vehicles (SIV) take a long time to put together and require delicate balances of assets and liabilities to make profits. They are also experiencing spread tightening, much like every other structured finance asset class. Yet the market has expanded to $250 billion in outstanding assets, prompting market players to draw distinctions between the SIV structure and their spin offs, SIV-lites.'
"These recently coined SIV-lites, have common features to both market value CDOs and some features common to SIVs," said Patrick Clerkin, senior director of European structured finance in the London office of Fitch Ratings.
For starters, structured investment vehicles hold long-term assets and issue commercial paper and medium-term notes. They generate profits through arbitrage plays between their assets and liabilities, and from management fees.
Structured investment vehicles can deliver big yields. Aside from getting funding through CP and MTNs, they use a capital piece, which can be leveraged up to 15 times. Depending on the level of capital in a SIV's initial funding, it can generate a profit of about 240 basis points, which is split between the manager and the capital.
Currently, SIVs have been generating profits of between 150 basis points and 200 basis points. Although that is slightly lower than the 200 basis-point profits that SIVs were generating four years ago, managers are still attracted to the vehicles because of their stable, annuity-like returns, Clerkin said.
Structured investment vehicles also have very efficient liquidity management features. Although committed liquidity can vary, Clerkin said, "SIVs are efficient in the sense that they can get away with 5% to 10% of pure liquidity support. CDOs would have required 100% liquidity, which is costly."
They are also expandable, because managers can easily add assets.
The market kicked off in 1988, when two bankers who worked in Citibank's London office at the time, came up with the idea for the structure. That SIV, Alpha Finance, was created in response to volatility in the capital markets at the time. Investors wanted a highly-rated vehicle that would yield more stable returns on their capital, said Henry Tabe, a managing director for Moody's Investors Service's London office.
Structured investment vehicles used to take up to 24 months to put together, because managers had to raise money for the capital portion. Usually, one SIV hits the market a year, but the market saw something of a glut in 2002.
"In 2002 six vehicles came to market," Clerkin said. "That was the most popular year. Those vehicles were obviously thought about in 2000, 2001, and spreads were quite wide then. The proposition was quite attractive."
Sources say that about 20 SIVs are now in operation.
Although European financial institutions such as U.K.-based investment manager Gordian Knot and Dresdner Bank are among the sector's key players, SIVs also operate in the U.S. where Citibank plays a big role in the SIV market.
The lite' version
The segment also has an imitator - commonly called SIV-lites. They also go by the names hybrid SIVs and market value CDOs. Whatever the label, ABS professionals are talking about how to draw clear distinctions between the original and its byproduct.
While SIVs fund themselves using CP, MTNs and capital notes, SIV-lites tend to draw funding from CP and the capital notes.
SIV-lites, or hybrid SIVs, face the same key risk, namely refinancing risk, as SIVs. If a market disruption leads to an inability to roll CP, both vehicle types would be compelled to liquidate assets. This, however, is not quite the case with market value CDOs, which typically have term liabilities. All three vehicle types, however, share a common asset-side concern for portfolio mark to market, Tabe said.
SIV-lites are typically much smaller than traditional SIVs, averaging $2.5 billion, compared to $10 billion for SIVs. Sigma Finance Corp., for one, has a balance sheet of about $49 billion.
Also, leverage for SIVs is dynamic, whereas SIV-lites tend to issue capital upfront. Because of these two factors, SIV-lites have a much less intensive treasury function, and are generally operationally lightweight compared to SIV.
"This is probably the origin of the lite' accolade," said Tabe, who tends to call the instruments hybrid SIVs.
"Many SIV managers are not fans of the term SIV-lite'," Clerkin said. "In some people's eyes, these are market-value CDOs with a few bells and whistles on them."
Market players also disagree as to whether the SIVs should be considered a stand-alone asset class. Some say that SIVs are part of the asset-backed commercial paper market, because they issue MTNs, and the Federal Reserve includes SIV holdings in its tally of ABCP outstandings.
Conversely, some argue that SIVs are in a class by themselves.
"People compartmentalize SIVs into ABCP, as well as into CDOs, hedge funds and arbitrage funds," Tabe said. "SIVs have characteristics similar to all these vehicle types, and so people tend to see them as similar to what they are most familiar with - a bit like the elephant and the blindfolded."
While there are similarities between SIVs and all of those vehicle types, Tabe said, they do not slot neatly into any one of those categories.
Whatever the term or grouping, ABS professionals agree that structured investment vehicles are likely to expand their holdings, as managers try to stay ahead of today's tightening yields. A manager that waits for yields to widen before buying certain assets might want to rethink that strategy, Clerkin said. Instead, it might be better to continue buying assets, knowing that there is an excellent chance that current spreads will tighten a month later.
Also, it is easier to set up the instruments these days, because the capital needed to set them up is more readily available.
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