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Monday, November 12, 2007

Little Confidence in SIV Super Fund

by Calculated Risk on 11/12/2007 12:19:00 AM

From Eric Dash at the NY Times: Some Wonder if the Banks’ Stabilization Fund Will Work

... Will it actually help?

The answer, some analysts and big investors say, is probably not much. The backup fund will not save troubled structured investment vehicles, or SIVs, that hold billions of dollars in packaged loans, though it could delay their demise. It may help calm the turbulent credit markets by preventing a sharp sell-off of securities ...

The hope is that the backup fund will allow time for asset prices to recover, although most market analysts call that improbable. But if the backup fund helps SIVs avoid sell-off, those investors may lose less money. Prices vary, but even amid a deteriorating market, some analysts say that the bulk of SIV assets are still fetching between 97 cents and 98 cents on the dollar.
The backup fund will not purchase the most distressed assets in the SIVs. Bank organizers agreed that it would not accept any subprime mortgage-related assets and only certain types of risky complex instruments like collateralized debt obligations.
“Will this resolve the basic issue of the assets of the SIV trading below what they were originally?” asked Steven Abrahams, the chief interest-rate strategist at Bear Stearns. “No, it defers the day of reckoning.”
It doesn't sound bad with assets "fetching between 97 cents and 98 cents on the dollar", however, because of leverage, this puts the SIVs right on the threshold of a possible enforcement event.

As noted in my earlier SIV post, Fitch rated SIVs average 14 times leverage. So, if an SIV had $1 Billion in capital, and an additional $14 Billion in leverage (mostly from selling commercial paper and medium-term notes), the SIV would hold $15 Billion in assets. If the typical asset was "fetching between 97 cents and 98 cents on the dollar", that would be a loss of $300M to $450M, or a loss of 30% to 45% of capital (from the $1 Billion) giving a NAV of 55% (97 cents on the dollar) to 70% (98 cents on the dollar).

According to Fitch, if the NAV for an SIV falls below 50%, then the fund might face an enforcement event, and it might have to be liquidated. Once the assets of one fund were liquidated - say at 96 cents on the dollar - that would mean the NAVs for other SIVs would probably fall below 50% - and they might also have to be liquidated, further depressing prices.