Strucured Investment Vehicle - SIV

A structured investment vehicle, or SIV, is an asset class similar to a hedge fund which uses high leverage on investor capital to purchase assets.  It is suggested that the leverage is in the area of 13 times.  The basic premise of a SIV is to leverage investor capital as collateral to borrow large sums of money through the issuance of short-term commercial paper; using the proceeds to purchase assets such as high quality asset backed securities & mortgage backed securities.  The simple idea here is to profit from the leveraged spread between borrowing costs (commercial paper interest rate) and lending costs (bond security yields).

How are SIVs Structured?


SIVs are structured typically in tranches, junior and senior.  Senior debt is usually rated AAA while junior debt is in the BBB area.   Senior debt is typically consists of medium term notes and commercial paper while junior debt is made up by puttable bonds with short term to medium term maturity.  Senior debt is supported by banks through a back-stop facility which will guarantee liquidity to the senior debt holders in the event of a market breakdown which would prevent the SIV from refinancing their short term debt.

SIVs & Mortgage Crisis of 2008


With the liquidity boom since the housing market started to take off, money was easy to borrow and easy to borrow at very favorable rates.  When business was good, it was really good; however, when the mortgage markets began to tumble, so did everything that was tied to it.

The drop in housing prices, coupled with the inability of borrowers to pay their mortages off caused a deluge of defaults which naturally trickled down into MBS securities, whose success depends on borrowers making their payments.  As we suggested above, SIVs used massive leverage to purchase these securities which began to tumble.  Let's divert to another issue and then come back to this one so we can understand why the drop in MBS became so severe. 

The second issue that SIVs encountered was due to the asset/liability mismatch that we discussed above.  Basically, they are issuing short term paper to invest in long term assets.  Once the short term paper matures, SIVs need to return the borrowed funds and re-borrow to keep the leverage in place.  Once the housing crisis began, liquidity started drying up throughout the financial system and came to a dead halt for these SIVs.  They were not able to issue any paper at any cost.  This is where the term "deleveraging" becomes relevant.  In order to pay their maturing debt liabilities, SIVs were forced to liquidate, or deleverage their portfolio, by selling their assets and pay off their debt holders. 

Now back to our discussion from two paragraphs earlier; when the SIVs began deleveraging, they all began selling and a massive supply came into the market with unmatched demand causing a waterfall decline in these securities.  Basically, they were forced to sell at pennies on the dollar.

At the end of the day, many of the banks that back-stopped senior liabilities took massive writedowns to cover the huge losses, investors lost quite a bit of money as liabilities were greater than assets, and the SIV market was basically shut down.
Tim Ord
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