Siv Lites And Conduits Are The New Frankenstein

Discussion in 'Wall St. News' started by THE-BEAKER, Aug 28, 2007.

  1. forget subprime.

    siv lites and conduits are an even bigger distaster waiting to happen.

    in some cases they leveraged up 40 to 70 times.

    yes 40 to 70 times on SIV'S.


    Off-balance sheet woes raise wider concerns
    Published: August 24 2007 03:00 | Last updated: August 24 2007 03:00

    HBOS's annual report for 2006 covers almost 200 pages. But the document does not carry a single reference to Grampian Funding, the vehicle the bank uses to help lower its financing costs. So investors could be forgiven for expressing some surprise on Tuesday when HBOS announced that it would take direct responsibility for financing Grampian.

    Grampian, which has assets of about $37bn, is one of Europe's largest bank conduits. These are funding vehicles usually kept off a bank's balance sheets that have emerged as pivotal players in the current market turmoil. HBOS, the UK's fourth-largest bank, is the largest financial institution so far to publicly admit the effects of the drought in the market for asset-backed commercial paper, which conduits such as Grampian rely on for funding. But other banks are suffering as well.

    Across Europe, bank-owned conduits and other vehicles with investments in asset-backed securities are struggling to raise financing after the pension funds and insurance companies that normally buy their paper suddenly withdrew from the market. One of the best known example is a conduit operated by IKB, the German bank, which suffered heavy losses from investments in securities hit by the fallout from the US subprime mortgage market.

    Analysts at Moody's, the credit rating agency, yesterday described the liquidity situation in the asset-backed commercial paper market as "the tightest we have ever observed".

    HBOS made its Tuesday decision because the commercial paper markets were only willing to provide financing to Grampian on an overnight basis. The bank concluded it could fund the vehicle more cheaply by raising capital itself - yields on asset-backed commercial paper are now higher than on investment-grade corporate bonds.

    Investors' reluctance to buy commercial paper could have far-reaching consequences for the banking sector. Moody's estimates that conduits worldwide currently hold $1,200bn of assets. Most of this is guaranteed by the banks. So if the conduits were unable to issue commercial paper for several months, the majority of those assets would end up back on the banks' balance sheets.

    Not surprisingly, this has prompted some nervousness among investors - and bankers. The worry is that unwinding conduits, many of which were structured so banks could make more efficient use of their regulatory capital, will prompt a wider credit crunch that could feed through into the economy.

    However, such fears seem excessive. Analysts at Merrill Lynch estimate that if HBOS absorbs all of Grampian's assets, its Tier One capital, which stands at 7.7 per cent, will decline by 0.4 per cent. The impact on other European banks is even smaller. Moody's believes large commercial banks should be able to take on all the assets currently in conduits - and potentially absorb some losses on those assets - without undermining their credit ratings.

    In any case, the impact on capital will change at the beginning of next year, when European banks are due to adopt the Basel II framework, which does not distinguish between off- and on-balance sheet vehicles.Another concern raised during the recent turmoil has been the impact on structured investment vehicles, which are similar to conduits but are generally not as closely aligned with banks. The fear is that SIVs that cannot call on banksfor funding will have toliquidate, potentially triggering a further sell-off.

    However, industry observers point out that many large SIVs are extremely conservative, allowing them to unwind positions in an orderly way if funding becomes difficult. Unlike conduits, they are also not entirely dependent on the short-term commercial paper markets. For example, Sigma Finance, a long-established $50bn SIV run by London-based credit specialists Gordian Knot, depends on short-term paper for just30 per cent of its funding.

    Douglas Long, head of business strategy at Principia Partners, a software company that supplies risk management and accounting software to SIVs and other vehicles, says: "SIVs are differentiated from conduits and other structured products because by design they are never forced into rapid sales of assets and always have options. If they need to deleverage, they can do so in a slow, controlled and orderly manner."

    Nevertheless, some less conservatively managed SIVs are likely to face more difficulties. This applies particularly to a breed of vehicle known as SIV-lites, a type of collateralised debt obligation that relies on commercial paper to fund senior debt. Standard & Poor's issued a string of downgrades on a number of SIV-lite programmes late on Tuesday night.

    Observers point out that some of the longer-running SIVs have survived market panics such as the Russian government default, the collapse of Long Term Capital Management, and the terrorist attacks of September 11. Nevertheless, the market remains nervous.

    "Liquidity has become an issue for the sector and it is a concern. This is partly rumour and misinformation and partly people just running scared," said one SIV expert. "We are quite likely to see some of the weaker SIVs disappearing, but I hope that doesn't infect the whole sector."