SCOTTSDALE, Ariz. - The most popular buzzword at last week's SRI conference was "SIVs," or structured investment vehicles, and many firms seeking alternatives to traditional commercial paper conduit technology are currently setting up the structures, or have expressed interest to do so in 2001. Among these firms are SG Cowen, ABN Amro and Banc One. Not only will the structure comply with the liquidity requirements outlined in the new Basel Accord, but SIVs are fully hedged dynamic portfolios, offering many attractive advantages over traditional multiseller vehicles.
This wave of the future is not worry-free, however: even though SIV technology has existed for more than 10 years, market players describe the structure as largely "under wraps," "secretive" and "cutting-edge," leading investors to worry about a lack of disclosure which has become a trademark of SIV management.
In fact, Citibank, which first established the structure in 1988 under the Alpha Program, is said to be notorious for keeping its SIV technology secretive, sources said. Investors are wary, especially since it is difficult to fully assess the operating risk associated with the structure, and many say there is not sufficient openness for those who invest in these vehicles.
At a crowded pre-conference workshop on SIVs moderated by Mark Kahn, a vice president in the Institutional Trust group at J.P. Morgan Chase, panelists expressed concerns about the lack of disclosure and lack of understanding in the investor community pertaining to SIVs.
It is a tradition among SIV managers to be proprietary about the technology utilized for SIVs, panelists said. "Investors are in a last-to-know position," noted Jason Polun, a vice president and credit analyst with Merrill Lynch Investment Managers. Additionally, as the number of transactions increase and the size of portfolios grow, there is an increased risk that liquidation proceeds from an SIV will not be high enough to meet obligations to bondholders.
Access to liquidity
But this hasn't deterred banks, who are increasingly looking to the SIV structure in response to the changing regulatory landscape and the fact that liquidity is a big constraint for setting up traditional ABCP conduits. Several panelists mentioned that their firms are setting up SIVs, as it is a highly liquid funding source and a great opportunity to get more assets under management.
SG Cowen's Marty Finan mentioned that his firm is setting up an SIV through which all securities arbitrage vehicles will go. "SIVs provide clients with a wide array of structures, and do not require 100% liquidity support. Credit enhancement is done on a portfolio basis," Finan said.
The purpose of the SIV is, simply, to maximize the spread between portfolio yield and funding cost through the management of credit and liquidity risks in a fully hedged portfolio of highly rated securities. While the establishment of an SIV structure is a more intense process than building a CP conduit, SIVs require much lower liquidity levels, obtain the highest ratings, and have extensive and stringent reporting standards.
"SIVs are hedged against interest-rate risk, foreign exchange risk and valuation risk," said J.P. Morgan Chase's Kahn. "A very extensive infrastructure needs to be built around the development and execution of an SIV. That infrastructure includes technology, personnel, credit policy, analytic tools and FAS 133 accounting.
"SIV management includes weekly rating agency reporting, daily sensitivity testing, monthly audits and review of the annual financials. This technology infrastructure creates the control setting which is fundamental to successful SIV execution," Kahn noted.
Eclipsing CDOs?
Established in 1988 by Citibank, there are now 11 triple-A rated SIV companies in existence, sources said, with total assets of approximately $80 billion.
SIV management and administration goes well beyond CP conduits and CBO's in many respects, including the fact that the SIV portfolio is financed with a combination of equity capital, commercial paper, medium-term notes and bonds, based upon market conditions. Additionally, the extensive compliance and control model which is part and parcel of SIV management acts as a form of self-regulation.
More importantly, a number of organizations with experience in conduit management and CDO structuring have looked at SIVs as something that might be easy to implement. In fact, the structure is so attractive that some panelists said that it might eventually present better value than CDOs.
"These are bankruptcy-remote, and investment-grade weighted, and there should be much greater issuance in SIVs going forward," said Alex Roever, head of ABS research at Banc One Capital Markets. "SIVs might take over, as they might offer better value than CDOs. The portfolios are scrutinized and hedged out, and SIVs have lower default risks associated with them."
SIVs are similar to CDOs in the sense that companies do acquire, on average, double-A credit quality portfolios through triple-A funding. But with SIVs, the focus is not so much on managing credit quality, but on managing the liquidity risk inherent in the mismatch between assets and liabilities, and the entities' complex cashflow dynamics.
The CDO, on the other hand, can be thought of as a credit arbitrage product, as it finances a double-B portfolio with triple-A paper, and faces no liquidity mismatch, as the funding all occurs at the beginning of the deal.
Still, other panelists said that there are significant barriers to entry into the SIV market for CDO managers, including high initial cash outlays to develop technology, a significant learning curve, and the need for advanced modeling.
