August 22, 2007 / 9:55 PM / 10 years ago

SIVs, next shoe to drop in global credit crisis?

5 Min Read

NEW YORK, Aug 22 (Reuters) - Wall Street should keep its eye on a little-known coterie of investment companies run by European banks called "structured investment vehicles," or SIVs, which are having a tough time raising short-term funding.

These risky investment vehicles raise cheap cash by issuing short-term debt called commercial paper and buy higher-yielding securities, often U.S. mortgages, pocketing the difference.

But analysts say widespread failure in these vehicles could mean higher borrowing costs for U.S.-based companies that rely on the asset-backed securities market.

Unlike similar vehicles managed by U.S. companies and Wall Street banks to raise cash for operations and investments, SIVs rely on borrowed cash from other parties and do not have a bank behind them willing to fully repay investors in times of trouble.

Instead, SIVs, which issue 6 percent of the outstanding $1.15 trillion of U.S. asset-backed commercial paper (ABCP), assuage investor concerns by "marking" investments to market daily.

But that is cold comfort now.

Money-market funds, which are big buyers of commercial paper, are spooked by possible contagion from subprime mortgages, or risky home loans granted to low-credit home buyers, and are shunning commercial paper backed by assets.

As a result, SIVs can't raise any new funds and could soon be forced to dump more than $120 billion in investments -- including higher-rated securities backed by mortgages and collateralized debt obligations, or bonds backed by other types of debt -- on jittery investors who are already fleeing risk.

Such a massive unwind could further batter the nearly frozen U.S. asset-backed securities market, possibly even raising borrowing costs for U.S. companies like Ford Motor Co (F.N) that rely on its cheaper funding.

"These guys (SIVs) are one of the biggest buyers of asset-backed securities in the marketplace, and if one or two of them decide not to continue operations, that puts a dent in the demand" for securities, said a veteran in asset-backed commercial paper at a major Wall Street bank. That could "end up costing companies throughout the world more money."

Analysts at JPMorgan estimated on Friday that if 60 percent of SIVs unwind, or sell their assets, they could dump $45 billion in global securities backed by residential mortgages and $32 billion in collateralized debt obligations, or CDOs.

"The numbers are extraordinary," JPMorgan analysts Christopher Flanagan, Edward Reardon and Amy Sze said in a report. "Dealers do not have balance sheet capacity for this paper."

According to Standard & Poor's, the largest SIV programs as of July 13 were Sigma Finance, run by Gordian Knot, a London-based firm that is 32 percent-owned by Deutsche Bank; Cullinan Finance, run by HSBC Bank; and K2 Corp., run by Dresdner Kleinwort.

To be sure, SIV managers have a pile of emergency cash on hand and are pursuing other avenues, like short-term loans called repurchase agreements, to hoard more cash and wait out the investor boycott.

But SIVs may not be able to wait longer than several weeks before unloading assets to repay investors.

Distant cousins of SIVs, called "SIV-lites," are already deep in trouble and selling assets.

Roughly $4 billion of securities, much of it backed by home-equity loans, has been coughed up by these vehicles, which are less diversified and more leveraged than SIVs, with a focus on subprime-related debt.

A SIV-lite run by UK hedge fund Solent Capital Partners LLP on Monday said it may be forced to sell assets, as it has been unable to raise short-term funding. For details, see [ID:nL20821410]

Standard & Poor's on Wednesday cut its ratings on two SIV-lite vehicles run by Solent Capital Partners and Avendis Financial Services by up to 17 notches, an unusual move since such steep downgrades are extremely rare. [ID:nL22873424]

S&P also said it might also cut its ratings on notes issued by Sachsen Funding I, managed by Landesbank Sachsen and Cairn High Grade Funding I, managed by Cairn Financial Products. There is only one other SIV lite, Duke Funding High Grade II, managed by Ellington Global Asset Management.

But the damage could also end up stopping at SIV-lites, which actually own subprime-related debt whereas SIVs generally do not, analysts said. SIVs also issue other types of securities besides ABCP for funding.

SIV-lites may have more in common with certain types of CDOs, which have been pummeled in recent months, and are often run by CDO managers, analysts said.

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