Tuesday, September 11, 2007

Fleck on Structured Investment Vehicles

by Calculated Risk on 9/11/2007 09:35:00 PM

From Bill Fleckenstein: Leveraged Black Boxes (Fleck's Site):

Note: Excerpted with permission. SIV: Structured Investment Vehicles.

"... though London appears to be the epicenter of conduit angst these days, our homegrown Citicorp appears to have plenty of exposure. That, according to the Lord of the Dark Matter, who in an email to me rattled off the following list of its SIVs: Beta Finance, Centauri, Dorada, Five Finance, Sedna Finance, Vetra Finance, and Zela Finance. He was able to obtain a portfolio commentary for Beta Finance ...

First of all, for those folks who can't quite wrap their arms around what an SIV, SPIV, or conduit is, those names all stand for pretty much the same thing -- special-purpose entities that reside off balance sheet. Think of them as virtual S&Ls, which can be quite sizable. ... And, because they're off-balance-sheet, they operate with little regulation.

The better question is: why these entities exist in the first place, and in such size. I think we know the pat answer -- so that financial institutions can employ them and utilize even more leverage than they are legally allowed to. ... Citicorp notes that the leverage in this particular vehicle, Beta Finance, is "only 14.24 times." Thus, Citicorp, a leveraged entity, owns a gaggle of leveraged S&Ls. ...

Next, Citicorp says: "We highlight that all US CMBS exposure is super-senior." What I find interesting in that comment: They've taken pains to note that their commercial mortgage-backed paper is the highest rated -- implying that there might be a problem with lesser-rated tranches of commercial mortgaged-backed paper.

That echoes a data point provided by someone wishing to remain anonymous, who resides near the top of the lending food chain at one of the world's largest banks. The source indicated to me that commercial mortgage-backed securities will also see problems. Though I did not get the impression from her that the timing was imminent, the weakness in the commercial version of the ABX index indicates that some pain is already being dispensed, even if there has been little spilled on this subject."
Note: According to Goldman Sachs, the problem is more acute in Europe, because the European regulations allow SIVs that would be on balance sheet in the U.S., to stay off balance sheet in Europe.

Earlier this year from Fleck:
January 14, 2007:
... a former top executive at a subprime lender (whose chronicling of the unwind has been amazingly accurate and timely), told me that serious issues are developing, and that large companies like New Century Financial (NEW, news, msgs), Accredited Home Lenders (LEND, news, msgs) and NovaStar Financial (NFI, news, msgs) will, in his words, "hit the wall" very soon.
January 30, 2007:
Turning to the subprime industry, once again I heard from my friend who has been staggeringly accurate. He continues to feel that things are about to really get worse. In an email to me, he wrote: "Scratch and dent loans are killing everybody. Bids that were 92 or 93 are now low to mid-80s. It is a bloodbath, and is pressuring even strong companies to buckle. NO ONE is making any money in the market right now. We are at a point of no return for many. The next two weeks will be wild."
Note: A wild two weeks indeed as subprime blew up in early February.

March 14, 2007:
My friend in subprime updated me last night, as follows: "The Alt a space has deteriorated very quickly, but not yet public. $40 billion in subprime still waiting to find a home. No loans will be bought at attractive prices until May production as it will be underwritten to new guidelines. The triple bbb's are a mess. The hedge funds that bought it are all in trouble. ... warehouse guys and Alt a guys are now next. Alt a guys may be worse as less insurance on those loans to protect them. The loan sizes are bigger as well."