Impact of credit crunch While this way of structuring SIV operating documents was supposed to provide for an orderly realisation of assets and repayment of creditors of SIVs in financial difficulties, in practice it has limited the options both for receivers trying to restructure troubled SIVs, and for creditors who want to recover their debts. According to Steinberg, part of the reason the operating documents presented challenges was the radical change in economic circumstances.
Legally, this constrained receivers and creditors in terms of what action they could take to achieve a particular commercial result. When SIVs began to breach early tests and move into restricted operating mode, some financial sponsors that had created SIVs effectively took troubled SIVs onto their own balance sheets, even though the sponsors had no contractual obligation to do so.
In other cases, the sponsor was not willing to take the SIV back on balance sheet; for example, Standard Chartered did not save Whistlejacket. Early restructuring options Some SIVs reacted to the funding problem early, and were able to restructure before an enforcement trigger was breached. It was able to replace its commercial paper with long-term funding provided by a bank linked to the cash flow rather than the market value of its assets, essentially converting its borrowings into a cash flow CDO.
While in restricted operating mode, some SIVs were able to refinance their liabilities in the repo markets, by selling the underlying debt securities they had invested in to third parties for cash and agreeing to repurchase them at a later date for a specified price a repo is essentially a loan of the cash for the period, secured by the transfer of the underlying asset. This allowed the SIV to receive cash to repay senior creditors whose notes were maturing. While the SIV is not de-leveraged, the leverage is shifted from the commercial paper holder to the repo counter-party.
Under this type of restructuring, the capital note holders received assets from the SIV in exchange for their debt. Other SIVs looked at longer-term funding, such a setting up a liquidity facility or asset purchase facility. Some SIVs were able to amend their documents, in particular by removing the net asset value triggers, to try to reduce, or delay the likelihood of enforcement, while other restructuring options were being considered. This was important because, once a SIV enters enforcement mode which is what happened to Cheyne, Rhinebridge, Axon, Orion and others , the options for restructuring under the documents are more limited.
Although the receiver is appointed by the security trustee, legally, the receiver is an agent of the SIV, as the security trustee will not want to assume liability for the receiver. The receiver will contract out of any personal liability, both before it is appointed and at various stages of the receivership.
The effect on a SIV of entering enforcement mode varies. For other SIVs, assets need only be liquidated as liabilities fall due, unless and until an insolvency event occurs. Receivers and creditors were keen to avoid a fire sale of SIV assets following the sharp drop in the market value for debt securities, and the fact that potential buyers had largely abandoned the market. An additional problem was the fact that the market as a whole had been affected, so the sheer volume of assets to be sold was unprecedented.
Multiple options One of the difficulties faced by the receivers in deciding what action to take is that SIVs usually have a diverse creditor base. For that reason, the receivers wanted to find a restructuring solution that took into account the various creditor preferences, and provided them with a number of options to choose from. Cheyne model Cheyne was the first distressed SIV to be restructured to provide multiple options for the creditors. The restructuring deal needed to comply with this legal requirement, while still providing a multi-option solution for creditors.
With such a diverse creditor base, that would not have been feasible. Deal structure The receivers and Goldman Sachs entered into a restructuring agreement that provided the creditors with three options:. Option one: receive a cash payout.
While creditors would potentially receive less than the face value of their original investment, this option was attractive for low-risk creditors who preferred to realise any losses and exit the investment. Option two: remain invested in the assets through a new vehicle set up by Goldman Sachs, called Gryphon.
Gryphon would then use those proceeds to buy and manage a proportion of the assets owned by Cheyne, so that investors could benefit from any recovery in asset value. For tax and accounting reasons, this option was preferable to receiving cash for some creditors. Options two, three and four were not part of the receivership and were arranged by Goldman Sachs. The size of the slice auctioned was determined by what portion of the creditors chose the cash or ZCN option.
Goldman Sachs then immediately on-sold the assets to Gryphon for the same price. Before the deal took place, creditors had a period of time to consider the alternative options. Creditors who took no action would receive cash. Alternatively, those who chose option two were required to assign to Gryphon their entitlement to the proceeds of sale. In exchange for the proceeds, creditors were issued pass through notes.
Creditors who chose option four surrendered their pass through notes in exchange for a portion of the assets to manage themselves, although this option would only be available once the restructuring was complete. Creditors who wanted ZCNs in option three were required to pay a sum equivalent to their cash distribution to Goldman Sachs. Additional legal challenges The restructuring also faced the following legal challenges:.
US securities law. This meant that Gryphon had to comply with US tender offer rules when issuing the pass through notes, as these constituted offers of new securities to US investors. However, pass through notes are a different form of investment.
They are more quasi-equity than debt, and to choose whether to take this option, the creditors would likely have reviewed much more carefully the available information about the assets Gryphon would hold. Goldman Sachs provided preliminary indicative prices for the assets, to assist creditors in valuing the options. The bidders in the auction process also gave indicative non-binding offers prior to the start of the auction.
Creditors were kept abreast of the pricing information emerging from the auction process through a website set up for that purpose. Creditor communication. Developing and seeking support for the restructuring deal meant that the receivers and Goldman Sachs needed to communicate frequently with the senior creditors.
This was made difficult by the fact that, in raising its capital, Cheyne had used global notes that were issued through and held by clearing systems as is the case with most funds raised on the capital markets. A global note represents the creditor claims and is held by a depository, which then interfaces through the clearing systems with a number of participants, mainly financial institutions who are members of the clearing system.
The depository holds the note on trust for the participants. Consequently, the creditor is at several removes from the issuer. Cheyne dealt only with the clearing system, and did not actually know who its creditors were. This is a frequent problem in restructuring situations where funds have been raised on capital markets, but it was particularly acute in this case because of the specific structure of the deal. This would have altered the form of the note into a series of bilateral relationships, providing for easier identification of creditors; however, this raised various other administrative and documentary challenges, so was not appropriate in this case.
Further, many of the creditors did not want to be identified publicly. When is a SIV insolvent? In the wake of the credit crunch, Cheyne was forced to liquidate some of its assets to repay its maturing commercial paper. The Bank of New York as security trustee was obliged to appoint receivers under the terms of the security trust deed. The receivers applied to the English High Court for directions on how they should apply monies coming into their hands during the period between their appointment and the occurrence of an insolvency event if one should happen as defined by the security trust deed.
At that time, the receivers took the view that they had insufficient information to say that an insolvency event had taken place, but one might occur in the future. Your current browser may not support copying via this button.
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Show Summary Details Overview structured investment vehicle. SIV An arbitrage fund that raises finance by selling asset-backed commercial paper CP and medium-term notes and invests predominantly in asset-backed securities ABSs.
Reference entries structured investment vehicle in A Dictionary of Business and Management 5 Length: 67 words. View all related items in Oxford Reference » Search for: 'structured investment vehicle' in Oxford Reference ». All rights reserved. Sign in to annotate.
|Forex trading coaches youtube videos||However, pass through notes are a different form of investment. Asset-backed securities, which include CDOs and MBSs, can enhance investment returns, especially when the market doesn't. At the end of the term, the holders of CDOs can retrieve the borrowed capital from the initial borrower. If the special investment vehicle underperforms or, worse, defaults, this can have a negative impact on the sponsor. Partnerships, trusts, LLCs can also be examples of special purpose investment vehicles. Cheyne Capital.|
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They are considered to be part of the non-bank financial system, which has two parts, the shadow banking system comprising the "bank sponsored" SIVs which operated in the shadows of the bank sponsors' balance sheets and the parallel banking system, made up from independent i. Invented by Citigroup in , SIVs were large investors in securitization. Some SIVs had significant concentrations in US subprime mortgages , while other SIV had no exposure to these products that are so linked to the financial crisis in The strategy of SIVs is the same as traditional credit spread banking.
They raise capital and then lever that capital by issuing short-term securities, such as commercial paper and medium term notes and public bonds , at lower rates and then use that money to buy longer term securities at higher margins, earning the net credit spread for their investors. Long term assets could include, among other things, residential mortgage-backed security RMBS , collateralized bond obligation, auto loans, student loans, credit cards securitizations, and bank and corporate bonds.
Beta had leverage of up to 10 times capital but leverage was based on risk weightings of the assets. Investors wanted a highly-rated vehicle that would yield more stable returns on their capital, said Henry Tabe, a managing director for Moody's Investors Service's London office. In , Professor Frank Partnoy wrote, "certain types of so-called 'arbitrage vehicles' demonstrate that companies are purchasing credit ratings for something other than their informational value.
A typical SIV is a company which seeks to 'arbitrage' credit by issuing debt or debt-like liabilities and purchasing debt or debt-like assets, and earning the credit spread differential between its assets and liabilities. Much of an SIV's portfolio may consist of asset-backed securities. It earns this spread by accepting two types of risk: a credit transformation lending to AA borrowers while issuing AAA liabilities and a maturity transformation borrowing short while lending long.
The scale of both transformations were considerably less than traditional banks, and leverage was also typically half to a quarter of that used by banks, so the risks were less and the returns available were also much lower. The introduction of Basel I regulations made holding bank capital and asset-backed securities ABSs expensive for a bank, depending on the ratings assigned by one of the Government sponsored ratings agencies.
Bank capital securities, such as dated subordinated debt could be weighted as highly as to amount to a deduction from capital. That is to say all the investment would be funded from capital. A 'loophole' in the Basel accords meant that banks could provide a liquidity facility to the SIV of up to days without holding capital against it so long as it was undrawn.
Partnoy then questioned the economic theory of SIVs: "How is the SIV able to earn such an 'arbitrage' spread between its assets and liabilities? If the SIV is simply a vehicle for purchasing financial assets, it should not be able to fund purchases of those assets at a lower rate than the rate on those assets.
If it could, market participants with low funding rates would simply purchase the financial assets directly, and capture the spread for themselves. Portnoy's theory misses the simple fact that the SIVs raised capital from third party investors with which to enhance the liabilities so these were not simple pass-through structures.
Those investors benefitted from the SIV raising funding on their behalf at lower rates than they could themselves due to the tight criteria required by the rating agencies. Alpha's maximum leverage was five times. Beta's leverage was up to 10 times, depending upon the quality of its asset portfolio.
Typically banks are leveraged between 25 and 50 times, so most SIVs operated with leverage of approx half that of traditional banks. As of September , one paper reported: "All SIVs to date have been established in either the Cayman Islands or Jersey so as to benefit from certain zero-tax regimes available in those jurisdictions. As mentioned, the SIV will usually also establish a subsidiary in Delaware to facilitate the issuance of debt in the US domestic market. The debt issued in the US will either be guaranteed by the offshore parent, or co-issued by the SIV and the subsidiary.
A SIV may be thought of as a very simple virtual non-bank financial institution i. Instead of gathering deposits from the public, it borrows cash from the money market by selling short maturity often less than a year instruments called commercial paper CP , medium term notes MTNs and public bonds to professional investors.
This enabled them to borrow at interest rates close to the LIBOR , the rate at which banks lend to each other. The gathered funds are then used to purchase long term longer than a year bonds with credit ratings of between AAA and BBB. These assets earned higher interest rates, typically 0.
The difference in interest rates represents the profit that the SIV pays to the capital note holders part of which return is shared with the investment manager. The short-term securities that a SIV issues often contain two tiers of liabilities , junior and senior, with a leverage ratio ranging from 10 to 15 times. The junior debt may or may not be rated, but when rated it is usually in the BBB area. There may be a mezzanine tranche rated A.
The junior debt traditionally comprises puttable, rolling year bonds, but shorter maturities and bullet notes became more common. In order to support their high senior ratings, SIVs were obliged to obtain significant capital and liquidity facilities so-called back-stop facilities from banks to cover some of the senior issuance. This helps to reduce investor exposure to market disruptions that might prevent the SIV from refinancing its CP debt.
To the extent that the SIV invests in fixed rate assets, it hedges against interest-rate risk. There are number of crucial difference between SIV and traditional banking. The type of financial service provided by traditional deposit banks is called intermediation, that is the banks become intermediate middlemen between primary lenders depositor and primary borrowers individual, small to medium size business, mortgage holder, overdraft, credit card, etc.
SIVs do exactly the same, "in effect", providing funds for mortgage loans , credit cards , student loans through securitised bonds. In more traditional deposit banking, bank deposits are often guaranteed by the government.
Regulators assume that deposits are stable as a consequence. On the other hand, the money market for CP is far more volatile. There are no government guarantees for these products in case of default, and both sellers and lenders have equal power at setting the rate. This explains why the borrowing side of SIV consists of fixed term 30 to days rather than on-demand 1 day deposits; however, in extreme circumstances like the credit crunch, the worried usual buyers of CP, facing liquidity worries, might buy more secure bonds such as government bonds or simply put money in bank deposits instead and decline to buy CP.
If this happens, facing maturity of short term CP which was sold previously, SIV might be forced to sell their assets to pay off the debts. If the price of asset in depressed market is not adequate to cover the debt, SIV will default. On the lending side, traditional deposit banks directly deal with borrowers who seek business loans, mortgages, students loans, credit cards, overdrafts, etc.
Each loan's credit risk are individually assessed and reviewed periodically. More crucially, the bank manager often maintains personal oversight over these borrowers. In contrast, SIV lending is conducted through the process known as securitization. Instead of assessing individual credit risk, loans for example, mortgage or credit card are bundled with thousands or tens of thousands or more of the same type of loans.
According to the law of large numbers , bundling of loans creates statistical predictability. Credit agencies then allocate each bundle of loans into several risk categories and provide statistical risk assessment for each bundle in similar manner to how insurance companies assign risk. At this point, the bundle of small loans is transformed into a financial commodity and traded on the money market as if it were a share or bond.
Most SIVs experienced no credit losses. The risks that arise are the same that Banks have always faced: First, the solvency of the SIV may be at risk if the value of the long-term security that the SIV has bought falls below that of the short-term securities that the SIV has sold. Banks typically avoid this risk by not marking to market their loan portfolios. Second, there is a liquidity risk , as the SIV borrows short term and invests long term; i.
Unless the borrower can refinance short-term at favorable rates, he may be forced to sell the asset into a depressed market. When a traditional deposit bank provide loans such as business lending, mortgage, overdraft or credit card, they are stuck with the borrowers for years or even decades. Therefore, they have incentive to assess the borrowers' credit risk and further monitor the borrowers finance through their branch managers.
In securitised loan, those who originate the loan can immediately sell off the loan to SIVs and other institutional investors and these buyers of securitised loans are the ones who are stuck with credit risk. Therefore, in SIV intermediation, there is the same incentive to assess credit risk of borrowers, as they expect to hold the asset to maturity. However, the loan originators', typically a Bank's, reward is structured so that as more loans are made and sold wholesale, more commission will be earned.
So there is little need for bank originators to monitor their borrowers' credit risk. The monitoring was the responsibility of the end investor in the securitised tranches and, theoretically, the rating agencies. Upon review, it is evident that the credit risk assessment conducted by these forms of lending was far more inadequate than with the traditional lending done by deposit banks although many large traditional Banks turned out to be over-exposed to mortgage risk both via loans and through their investments in securitisations.
In traditional banking, when a downturn occurred, branch managers could individually review clients' financial condition, separate good borrowers from bad ones and provide individually tailored adjustments. This is a type of loan that is provided by a group of banks and non-bank institutions to a single borrower.
A syndicated loan is generally a source of financing used by large corporations across Europe and the US. It is arranged and administered by one or many commercial or investment banks, called lead arrangers. The syndicated loan allows individual lenders to spread the risk and enables them to take part in ventures, which may exceed their capital base. The loan has a term, an interest rate, and a repayment schedule. A synthetic finance product, the CDO is an asset-backed security ABS and represents a collection of securitized debt investments sold to investors and backed by collateral.
The issuance of CDOs is funded by the purchase of other portfolios of assets, such as commercial loans, corporate bonds, and also ABSs and mortgage-backed securities MBS issued by other special investment vehicles. These debt investments can include credit card loans, car loans, student loans, and bonds among others. At the end of the term, the holders of CDOs can retrieve the borrowed capital from the initial borrower.
CDOs were initially developed for the corporate bond market. However, over time they were actively used for the issuance of MBS. Another structured finance product, CBOs are complex debt instruments. The securitization of a pool of investment-grade bonds is backed by high-yield low-grade junk bonds that serve as collateral.
The issuer of CBO is known as a protection buyer. Because junk bonds have a higher interest rate than investment-grade corporate bonds, they are used in various proportions in the different tranches of the CBO. Senior debt, mezzanine debt, and subordinated debt and stocks are part of the tranches. The different tranches organize the priority of payments for the different debtholders.
CMOs are a type of mortgage-backed securities, mainly but not solely issued by U. CMOs are issued by third parties who through the issuance of these new securities obtain funds for creating new loans. Based on extensive and complex data, the issuer of the CMO will decide what portion of the principal and the interest of the underlying mortgage loan will go into each tranche. Usually, the cash flow from the mortgage loans is used to pay the interest in all tranches.
The principal, which is both scheduled payments and loan prepayments, is established through a complex schedule. The loan prepayment, or the settlement of debt before its due date, is a major risk for CMOs as it can affect cash flows. The prepayment is influenced by interest rates - decreasing interest rates can shorten the life of the CMO as the mortgage is paid more quickly or being refinanced while increasing interest rates can prolong the life of the CMO. A number of corporate loans are pooled together, including high-risk loans and loans made to private equity PE firms for leveraged buyouts LBOs , and sold to investors through securitization.
Each CLO is made of tranches with different maturities, credit risks, and payments. The tranches of a CLO are organized on the principle of priority - debt tranches have priority of payments over the equity tranches. Equity tranches don't receive payments whether in the form of principal or interest, however, they offer ownership in the CLO in the event of a sale.
A CLO is an actively managed instrument. The collateral that backs the pool of loans comprises first-lien senior secured bank loans made to a range of borrowers, typically companies. A credit default swap is a contract, which references single or multiple credits between two parties for the transfer of credit risk. The credit risk can come from emerging market bonds, MBSs, municipal bonds, and corporate debt.
The buyer of the CDS transfers the credit risk onto the seller in exchange for regular fees, acting as an insurance premium. The seller of the CDS benefits from the regular payments as long as a negative credit event does not occur. In the event of a default, the seller must compensate the buyer by delivering the principal and the interest on the bond involved in the transaction. The CDS only references the bond which is called reference obligation. The CDS has two main functions - to hedge against default and for speculation.
Structured finance products and their complex nature have a number of benefits, which, if used correctly, can enhance market liquidity, provide a hedge against unfavorable events, and facilitate access to emerging markets among others. As a risk management tool, structured products can mitigate credit risk through the use of credit derivatives - CDOs, MBSs. Interest rate risk can be effectively minimized by using CDSs. Structured products through the process of securitization provide more investment options to satisfy specific investment objectives that can't be otherwise met through traditional finance products bonds, loans, equity.
Asset-backed securities, which include CDOs and MBSs, can enhance investment returns, especially when the market doesn't. In addition, these advanced products are tailored financial products that provide more personalized solutions for niche business needs. They also allow access to capital for companies with various investment grades and give investors a greater choice for risk and reward.
Credit derivatives enable commercial and investment banks to shift the credit risk away from their balance sheets and onto investors such as pension funds, trusts, insurance companies, etc. This way, the financial institutions, the sponsors of an SIV using these structured finance products, can undertake riskier ventures without breaking any regulatory requirements for capital reserves, debt-to-equity ratios, and so on.
The SIV is an off- balance sheet item because it's not recorded on the parent company's balance sheet and doesn't appear as an asset or liability. An off-balance sheet item is not owned by the company and the company doesn't have any associated obligations. Another benefit of SIV is the ability to facilitate the transfer of assets to investors.
Non-transferable assets, such as property investments, and the process of securitization of non-tradable investments, such as mortgages, are typical examples of asset transfers. The risk associated with the issued debt obligations - In the event of default of the mortgage owner, the SIV may not be able to ensure payments to investors, based on the tranches of the financial product.
The prioritization of principal and interest payment ensures that each tranche is paid first before payments are made towards subsequent tranches that sit lower in the prioritization. The higher the risk of default the lower the prioritization ranking for a tranche. Investors who seek above-average returns also bear the increased risk, for which they are compensated through the higher interest rate.
In addition to the default risk, SIVs also present a risk regarding the debt rating of the different tranches. The unraveling and the contagion of defaulting mortgage payments shed light on the fact that some debt instruments had a worse credit rating than initially estimated. The insolvency risk is another risk that has to be taken into account. If the value of long-term investments falls there is an increased risk of insolvency, since SIVs make profits from the difference between selling short-term debt, usually asset-backed commercial paper ABCP , and buying long-term assets.
Prior to , ABCPs were considered liquid, long-term assets that had high credit ratings, and the maturity mismatch between them didn't give reasons for concern. A maturity mismatch means that short-term liabilities exceed short-term assets, that is - a company, for example, may not be able to meet its debt obligations as its assets, for instance, cash inflows, are insufficient to cover them. The issuance of short-term debt can create liquidity challenges. Further, the issuance of short-term debt can become problematic if it's used for the funding of long-term assets.
A maturity mismatch is also referred to as a liability-asset mismatch. A number of metrics exist to help gauge an insight into a company's liquidity position and flag any potential concerns. Among those metrics are:. The solvency ratios are expressed in percentages. The higher the percentage the higher the risk of financial distress for the company. The higher percentage also indicates that it is going to cost more for the company to raise funds through debt instruments.
Reputational risk - The reputational risk affects the parent company, or the sponsor, of the SIV. If the special investment vehicle underperforms or, worse, defaults, this can have a negative impact on the sponsor. The credit rating of the parent company could be affected. However, if the parent company experiences negative financial events, the SIV is not affected as it is an independent entity.
An SIV is also known as a bankruptcy-remote entity. This creates an asymmetric relation between the sponsor and the SIV as far as unfavorable events are concerned. Partnerships, trusts, LLCs can also be examples of special purpose investment vehicles. These legal and independent entities are created to fulfill a specific business purpose.
The main goal of a SPAC is to raise funds from both retail and institutional investors through an initial public offering IPO to acquire or merge with another company. The SPAC is an entity that has no revenue or business operations and its sole purpose is the acquisition or the merger with the target company. It is colloquially known as a blank-check company. The founders or sponsors of the SPAC create this entity in order to pursue business opportunities in an area or industry in which they have expertise and competence.
The target company is not initially identified as it would require additional scrutiny and disclosures during the IPO stages. The disclosure can result in complementary regulatory requirements that could prolong the process. The capital raised from investors is placed in a trust and invested in U. S Treasuries. It is not until after the IPO that investors know the target company. If the IPO is not completed within a specified timeframe, the capital, which is adjusted for fees, is returned to investors.
Alternatively, after the IPO the acquisition can be completed and the acquired company revealed. Investors will get an equity stake in the company proportionate to their capital contribution. Typically, it could take a few months for the target company to go public whereas a conventional IPO may require a year. Another advantage of the SPAC is that it may receive increased public attention if its sponsors are prominent and reputable business executives or financiers.
These entities aren't subject to much regulatory oversight compared to traditional financial institutions. However, there is a difference between U. S capital markets than in their European counterparts. The closest to a U. S-like regulatory regime is the Netherlands'. Neither is it required to supply audited financial statements for both the target company and the SPV.
Investors take a leap of faith in the management by trusting them that the acquisition will be successful. Regulation and disclosure requirements could alleviate risks posed to investors and create more transparency. When investors invest in SPACs they purchase units that contain shares and warrants, sometimes fractions of warrants. Warrants are contracts that give investors the right to purchase a specified number of shares in the future at a specific price.
The price is usually a premium to the stock price when the warrant was issued. An important element to be vigilant about is the redemption period. The redemption period is simply the deadline to exercise the warrants. Once the deadline has passed, warrants are no longer redeemable and they expire almost worthless. However, if the stock price is above the warrant strike price, issuing additional shares as a result of exercising the warrant, creates dilution.
In addition, bank and broker fees are paid in shares. The shares of the founders are known as the "sponsor promote".