Category / SIVs and Conduits

Owning things you don’t understand August 15, 2012 at 3:00 pm

Dealbreaker has an interesting article on a case involving Wells Fargo mis-selling SIV-issued CP to a muni. They go through the specifics of the case (which are outrageous – the salesguy didn’t know what a SIV was when he sold them the paper), but then they riff on the structure of the system that let this happen.

If you think it’s a bad thing that various municipalities got singed when a bunch of overlevered investments in subprime securities blew up – and you do, right? what are you, a monster? – then where do you place the blame? The municipalities? I mean, sure, absolutely, they were dopes, but their job was to be dopes – they thought they could rely on layers and layers of paid advisors who seemed to owe them something. The people who built the SIVs? Yes, they were clearly arbitraging the inattention of various other parties in order to maximize profits, so, bad on them, except: they were traders, and arbitraging others’ inattention (within antifraud rules, etc.) was their job. The rating agencies? Absolutely: they were dopes too, but their job was not to be dopes, so bad work – but bad work protected by the First Amendment.

Brokers who put unsophisticated customers into these trades are a good target: unlike structurers and raters who can hide behind legal disclosure, the brokers’ job was actually to find suitable investments, so it’s fair enough for them to get in trouble when they didn’t even try to do that. So good work on the SEC for fining them – and for fining them an amount that, while pretty small, is still 100x what they made on selling this paper.

I have to agree with this. There’s nothing clearly evil about structuring SIVs. The ratings agencies could have done a better job, but given that there seems to be no legal sanction available to use against them, I guess we will have to let them lie. The people who are really culpable are the ones the muni paid to do their due diligence for them, and who should have been acting in their interests. But, as so often with professional advisors, there doesn’t seem to be enough at stake; sure, a fine is nasty, but shouldn’t the sanction for advising someone to buy something that you don’t understand and that isn’t suitable for them be higher than writing a cheque?

Circles in the Park, Lehman addition March 12, 2011 at 10:21 am

Bloomberg has a good article about Lehman’s Fenway CP conduit. It’s a complicated story so stick with me.

First, what was Fenway?

Lehman transferred dozens of loans and equity positions in commercial real estate to a conduit called Fenway Capital LLC… Then Fenway Funding LLC, a Fenway Capital subsidiary, issued short-term notes backed by the assets

So far, this is straightforward. Many banks had conduits which issued asset backed commercial paper (‘ABCP’) – notes backed by assets the banks had sold to the conduit.

The first slightly wacky part, though, is that Fenway didn’t buy the assets outright:

Lehman sold its real estate assets under a repurchase contract, or “repo”

Now, an ordinary conduit buys its assets. For Fenway to reverse repo them in implies that Lehman was on the hook for the ultimate performance of the asset; Lehman was just getting them off balance sheet temporarily. Moreover it implies that Fenway needed a lot less credit support for the assets than if it had had to get an A1/P1 ratings on its ABCP on the basis of owning the assets. But, as Moody’s put it:

Due to the distinct structure of repo conduits, there is direct linkage between the Prime-​1 rating of the repo conduit and that of the counterparties under the repurchase (​or similar) transactions into which the conduit has entered.

In other words, a repo conduit is only as good as the person who promises to repurchase the assets – Lehman in this case. (There is more on repo conduits c. 2007 here.)

The next bit, though, is whiffier than a well worn red sock.

Lehman bought the notes

This ought to have broken the scheme. If Lehman owned the notes Fenway Finance issued, then getting a deconsolidation opinion on the Fenway group would have been very hard. In effect Lehman would not have got the assets off balance sheet at all.

(Lest you think that Fenway had enough other buyers that Lehman would not have had to consolidate, Bloomberg tells you Lehman was the only buyer of its final issuance [of notes].)

The final step makes the whole game worthwhile for Lehman:

Lehman pledged Fenway notes as collateral to JPMorgan Chase & Co.

Thus Lehman has transformed collateral that JP would not have accepted, or at least not without a huge haircut, into an asset that they would, using the Fenway circus (and a small amount of credit enhancement). It’s clever. But is it legal?

Two thirds of a fine horse? April 30, 2009 at 1:59 pm

Not really. But the assets in Whistlejacket, the defaulted SIV sponsored by Standard Chartered, were liquidated yesterday, and reached an average price of 67.1 cents on the dollar according to Bloomberg. That means that anything more than 2 to 1 leverage in an off balance sheet funding vehicle is too much…

Cheyne Pain September 10, 2008 at 7:32 am

Ah, the lawyers may be slow, but they are remorseless. Like the slugs in my friend’s garden, there is little you can do to stop them. From the FT:

Abu Dhabi Commercial Bank’s class action lawsuit for fraud, negligent misrepresentation and unjust enrichment over its investment in a complex fund is a fascinating collection of details and allegations that cut to the heart of the credit boom and messy aftermath…

ADCB bought mezz notes paying Libor plus 150 and rated single A: these are now worth squat. Back to the FT:

ADCB’s suit accuses Morgan Stanley, Bank of New York Mellon, Moody’s Investors Service and Standard & Poor’s of misleading investors about the quality of assets the Cheyne vehicle bought and held from its inception in 2005 to its collapse just two years later.

This will be dramatic, even if it is the slow moving drama of a test match. I look forward to the show.

What’s the biggest SIV in the world? August 22, 2008 at 7:15 am

The ECB of course. Silly question. And they are even beginning to worry about it. The WSJ has details of an interview Nout Wellink gave yesterday. He is reported to have said:

“If we see that banks become very dependent on central banks, then we must stimulate them to tap other sources of funding,”

(It was in Dutch, however, so I can’t read the original.) What that stimulus will be, however, is an interesting question. Or is it time for a Spanish banking crisis?

When is an SPV yours? February 12, 2008 at 9:03 am

Standard Chartered has withdrawn support from its SIV, Whistlejacket. It appears that like many SIVs, the value of Whistlejacket’s assets has been falling fast. The contraction of the ABCP market meant that Whistlejacket had been unable to roll its short term funding. Standard had previously pledged to support Whistlejacket by writing it short term liquidity, effectively stepping in the place of the ABCP buyers. However it appears as if that liquidity line was contingent on the net asset value of the SIV being sufficiently big and, with falling markets, that test was no longer met. Hence any liquidity provided by Standard would not be contractually required – in Basel II terminology it would be implicit support. The consequences of taking Whistlejacket’s assets on balance sheet by providing implicit support were presumably too much for Standard Chartered.

This brings us to a difficult question that both regulators and accountants need to answer. When is an SIV yours, i.e. when should it consolidate for regulatory and/or accounting purposes?

A few thoughts.

  • Accounting consolidation should follow regulatory consolidation and vice versa. Whatever they do, the regulators and accounting standards folks should agree about when a securitisation is ineffective. If a SPV consolidates, there should be full regulatory capital on it. If it doesn’t then some measure of regulatory capital relief should be available.
  • The IAS (if not the FASB) consolidation rules are based on the ideas of control and benefit. Broadly the test for whether you consolidate a SPV require a test of who benefits from its activities and who controls it. The principles here are not bad, but I would suggest that they don’t allow for the idea of contingent control – mostly I do not control the SPV, but if something bad happens (like the closure of the ABCP market) then I get it back. Perhaps in order to clarify the situation consolidation should be automatic if an issuer has a position in multiple positions in the capital structure (such as equity and a supersenior liquidity line). That would at least make the assessment of benefit and control easier.
  • Regulators must accept that there are legitimate reasons for securitising assets and must provide a safe harbour for good structures. Failure to do this will not just damage the banks – it will damage the financial system.
  • Regulatory capital relief should be contingent on alignment of interests. Whenever the seller of an asset has an incentive to conceal information from the buyer, and especially if the seller is also the servicer, then clearly trouble is possible.
  • Regulatory capital relief should be based on the extent of the risk transferred. Overly penal rules which do not have this effect – such as Basel II – simply encourage regulatory arb transactions rather than genuine risk transfer. Despite a number of attempts the supervisors have not yet managed to write rules that do not permit capital arbitrage so there is no reason to believe they can get it right on the next attempt.
  • If issuers are found to have provided implicit support they should be required to restate their regulatory capital, earnings and balance sheets for all periods when they took advantage of the sham securitisation, and to make public disclosure of this restatement.

I do believe that securitisation is a useful tool for the financial system. We are still learning how to use it appropriately. Now a concerted effort is needed to rewrite both regulatory and accounting rules to incentivise effective structures. Making consolidation harder to avoid or capital higher won’t do that. It will just encourage another round of game playing which, when the next bubble bursts, will have even worse consequences.

Jump to the courts December 17, 2007 at 8:48 am

The WSJ reports an amusing scrap over Sagittarius, a $985M CDO sold to investors in March by Wachovia and structured, it appears, by Deutsche (who is the trustee). Several UBS funds are investors, and an MBIA affiliate, LaCrosse, is a swap counterparty to Sagittarius. Sagittarius has MBS assets so apparently there was a default event. What happened next is the interesting part:


The day after the event of default, LaCrosse sent Deutsche Bank a letter saying that no interest or principal should be paid to other junior noteholders.

Other investors, unnamed in the legal filing, disagreed, telling Deutsche that MBIA’s position “is neither reasonable nor correct,” according to court papers filed by Deutsche Dec. 3. These other bondholders also might disagree about how they would share continuing payments, assuming they got any money. The disputed payments total several million dollars and will pile up until the dispute is settled, according to a person familiar with the matter.

With its legal filing, Deutsche is essentially asking the court to guide it on whom exactly should be paid.

It appears MBIA’s view is that it is supersenior via the swap, and hence no one should get any cash until they are whole. The others, unsurprisingly, disagree. In any event this highlights the importance of understanding where any derivatives sit in seniority vis a vis the note investors. Default contingent market risk can be ugly, and it’s quite hard to hedge.

JP has the right take here I think. Analyst Chris Flanagan wrote in a report recently:


“If there’s one safe prediction for 2008, it is that legal teams will be busy”.

May all your reindeer in 2008 be made of pecans, or not, as you desire. Unless you are a lawyer, of course. They can find their own nuts.

The MLEC finally falls December 16, 2007 at 7:07 am

Vikram has bowed to the more or less inevitable and consolidated his SIVs. The MLEC is dead. Long live the MLEC. But not the capital noteholders, obviously. Now let’s see how long the dividend lasts. Anybody want to buy Smith Barney?

Vertical slices December 10, 2007 at 4:03 pm

From FT alphaville and worth quoting in full:

Citi’s SIVs have reduced their assets by $15bn in the past couple of months.

But it’s not the figure, or the reduction, that’s news. Speculation that the Citi seven currently have around $66bn under management was actually first mooted a little while back.

Here’s the interesting bit, about how the assets have been offloaded,

…through quiet side deals with some junior investors, according to people familiar with the business.

A bit more detail:

…people familiar with the vehicles say their size has been cut from $83bn at the end of September to about $66bn largely by selling pro-rata portions of a SIV’s portfolio of assets to investors in the most junior notes at market values. Citi is also talking to some investors about directly swapping their holdings for underlying assets.

In other words, Citi are basically saying to junior noteholders, that they’re unlikely to get anything back for their notes, but as consolation, they can buy assets from the SIV at market value – probably slightly below what they’re really worth. Quite an audacious palm-off. On the other end, we assume the money from these sales is being used to refund MTN investors (given that Citi are themselves assuming CP liabilities).

And as the FT report says, Citi is also looking at organising direct asset for note swaps.

Both of these have got to be negotiation intense options, surely with sky-high lawyers’ bills to boot. So the fact that they’re being pushed doesn’t sound like it bodes well for M-LEC.

Update. Some further background from S&P is here.

Liquidity puts November 22, 2007 at 7:50 am


It seems from FT alphaville that liquidity puts are not that well known. Here’s the gig. In any structure where a vehicle issues paper backed only by collateral (such as a SIV, conduit or securitisation) but where the paper has a shorter duration than the collateral, there is liquidity risk: if no one buys the paper, the issuer can have a problem regardless of solvency. To protect against this liquidity risk, many sponsors have bought liquidity lines, aka liquidity puts. Typically the issued liabilities are ABCP, and the liquidity put is an undertaking from a large well-rated and liquid bank that if the CP market does not want the issuer’s paper then (providing it is solvent) the bank will either buy the paper or lend the issuer money. This loan is often contingent on a general disruption in the CP market, and this type is also known as a backup CP line.

This structure was commonplace and many SIVs, conduits and other securitisation SPVs enjoy some form of liquidity support from a major bank. The problem is, as I noted earlier, many of these backup lines have been or will soon be triggered. You wrote it liquidity, you own it.

Between a rock and an accounting rule November 5, 2007 at 7:35 am

Naked Capitalism makes two interesting points about Citi:

  • Reading the Wall Street Journal we find:
    Citigroup’s subprime exposure — and source of its problems — are two big buckets that together total $55 billion, the bank said. The first bucket totals $11.7 billion, including securities tied to subprime loans that were being held, or warehoused, until they could be added to debt pools for investors. The second, totaling $43 billion, covers so-called super-senior securities.

    This position is larger than Merrill’s and so we can expect further very chunky write-downs from C at some point.

  • Moreover unlike mother M., Citi does not appear to have done much to reduce its position. Why might that be? One possibility is that if Citi had sold, they would have had a mark, and that mark in turn would have had to have been used for the same assets in their conduits. Those conduits would then have missed the OC tests, forcing Citi into the unpalatable decision between providing them with implicit support or suffering the reputational damage of not doing so. If this really is the case, Citi is going to have its work cut out staying afloat as these securities decline further in value.


It is worth thinking about what would have happened before securitisation. Had Citi had the same assets then, they would all have been on balance sheet in the banking book, and hence not marked at all. They would have had considerable discretion about the size and timing of loan loss provisions, and the only write-downs would have been from actual experienced losses. In short we would not have had any real idea of how bad the problem was. I rather prefer it this way round.

Snow down on the MLEC October 27, 2007 at 7:01 am


John Snow – Hank Paulson’s predecessor as Treasury secretary – isn’t that keen on the MLEC either. According to Reuters:

We’ve got all this paper out in the system, and my inclination is to say, let’s accelerate the price discovery process on this paper […]

We know that when you prop things up artificially — Japan — we know when you prop things up artificially — the (savings and loans) in the United States — you get bigger adverse consequences

He has a good point. Warren Buffett is not keen either:

I think there should be a requirement that before the securities are put into the new super-SIV, 10 per cent of the holdings should be sold into the market to people who are not associated [with the subprime problem]

Certainly the history of intervention to prop up prices in the markets is not encouraging, and suspicions remain that the MLEC will not use the right mark. Perhaps it falls foul of the Market Abuse Directive? Oh, and the ABX is on the way down again. Here are the 07-02 BBBs:

The Rock as a SIV October 26, 2007 at 8:06 am

FT alphaville has a nice post on Northern Rock, gathered from the Bank of England’s latest Financial Stability Review. They show this:

That’s massive asset growth funded by issueing securitised paper. Hmm, that sounds like a SIV to me. After all, a SIV is just a simple bank with no deposit funding. That’s NR these days.

Conduits and Consolidation October 24, 2007 at 9:01 pm

Bloomberg has an interesting article Citigroup SIV Accounting Looks Tough to Defend. The author, Jonathan Weil, makes the point that Citi is caught between the devil and the deep blue sea:

  • If it supports its SIVs, accounting consolidation kicks in since the firm is deemed to be providing implicit support and under FASB Interpretation No. 46(R) that brings them back on balance sheet.
  • If it doesn’t support its SIVs, the reputational damage will be severe.

Weil argues this is one of the reasons for the MLEC plan: it would allow Citi to dig some of SIVs out of the mud without forcing it to consolidate. This is a good point and it might well be true. But there is another dimension, too: regulatory consolidation. It is a little known (if deeply, deeply boring) point that regulatory consolidation is not the same as accounting consolidation.

Regulatory consolidation very roughly works by identifying which parts of the group are financial, putting all of their risk on the top company balance sheet, subtracting the equity invested in non-financial subsidiaries, and calculating regulatory capital on the result. Accounting consolidation again very roughly seeks to identify whether an entity which a firm has a relationship with is controlled by, owned by or gives the results of its activity to the firm. If so, that entity is consolidated. In detail the topic is complex, particularly in the context of firms which have both banks, insurance companies and other activities in a single group – financial conglomerates – or where careful structuring has been used to try to dodge the consolidation provisions of IAS 27, SIC 12 or whatever for a given securitisation SPV, SIV or conduit. For now, though, note that in principle at least an entity can be consolidation for accounting purposes but not regulatory purposes and vice versa. And that’s fairly odd. I can see that it makes sense to deconsolidate non-financial subsidaries of a financial holding company for regulatory capital purposes. I can even see how you might want to treat the same risk in different operating companies differently – for instance if a holding company owns both a bank and an insurance company. But the idea that an entity such as a conduit is consolidated for accounting purposes but not for regulatory capital seems deeply imprudent. And of course many conduits have been structured to ensure that provided no implicit support is given they will not consolidate for either purpose.

It is worth noting that for FAS accounters, FIN 46(R) on the Consolidation of Variable Interest Entities includes provisions for the recognition of an implicit variable interest, aka implicit support. This occurs amongst other things when a bank provides a conduit with credit or liquidity support that it is not contractually obliged to provide.

That brings us to the heart of the dilemma. Implicit support is poison. Regulators and auditors can only spot it after it has happened. But if conduit paper has been sold with a nod and a wink, so that the buyers expect implicit support and will exact reputational damage if it is not provided, then there is something rotten in the state of finance.

Sliding SIeVes October 23, 2007 at 12:33 pm

In sharp contrast to some mild improvements in other parts of the credit markets, FT alpahville presents this enlightening chart, courtesy of Fitch. It shows how the average NAV of the SIV’s assets has continued to slide.

The better players have been doing fine, but the worse ones are catching a severe cold, and the average is still declining. At this rate more triggers start to be hit, and forced liquidations are putting further pressure on prices. And that of course leads to more write downs. The rumor is that that $5B at Merrill is only the start for instance. We’ll see…

Update. It’s another $2.5B at Merrill, apparently. And that’s not the end of it, obviously, as the markets have been so illiquid that it is likely that all the big players still have a significant part of their position. Unless the recent ABX kickup is the start of a trend, there will be more writedowns like this.

The brotherhood of the MLEC October 22, 2007 at 10:12 am

Strangely enough, some bankers are not happy with the idea of Citi et al. manipulating the ABS market by waving assets into the MLEC at the wrong mark. From the FT:


A committee of top international bankers on Sunday warned that the proposed $75bn mortgage securities superfund must be transparent in its pricing of assets if it is to help restore market confidence.

The statement by the Institute of International Finance reflected concern that the superfund, which is backed by Citigroup, JPMorgan Chase and Bank of America, is proposing to buy assets from troubled investment vehicles at higher than true market prices. Josef Ackermann, chief executive of Deutsche Bank and chairman of the IIF, stressed the importance of “proper valuations” and the need for financial institutions to “take the hits”.

One does wonder if the ‘one conduit to rule them all’ plan is going anywhere…

What’s in it for the Treasury? October 16, 2007 at 9:05 am


The U.S. Treasury Department has been heavily involved in talks over the MLEC according to Bloomberg. Why, I wonder? It seems strange for a right wing Republican administration to interfere in free markets unless there is a very real systemic risk. Perhaps they know something about Citi we don’t that is worrying them. In any event the more we find out about this attempt to bolster the system, the stranger it seems.

Update. Greenspan has been sticking the boot in again. According to the FT he opined:


What creates strong markets is a belief in the investment community that everybody has been scared out of the market, pressed prices too low and there are wildly attractive bargaining prices out there. […] if you intervene in the system, the vultures stay away. The vultures are sometimes very useful.

This seems pretty reasonable. Providing an artificial mark via a non-open-market purchase of these assets into the MLEC, if that is indeed what is intended, will not be good for confidence.

Where’s the mark, Chuck? October 15, 2007 at 7:34 pm

The importance of my earlier question about how the MLEC will price the assets it is going to purchase is highlighted by an article in the FT today:


[It has emerged that] Axon Financial, a SIV linked with the US hedge fund TPG-Axon, had taken losses of $110m on sales of $3bn of its investments.

Very crudely scaling from $110m on $3b to Citi’s $100b in conduit assets gives us a loss of $3b. So we know a real mark to liquidation would really really hurt. The market is so illiquid at the moment that it’s hard to be sure until you try to sell of course. So it should be no surprise to learn that many banks have not yet marked their conduit assets down:


One banker said last week: “The banks have varied enormously in terms of how much they have marked down their books – of course there are some that want to avoid the big write-downs.”

The MLEC then looks like an attempt at creating a new vehicle the banks can claim is arms length and which they can use to justify valuations which might not really be liquidation levels. That helps in turn helps the banks other conduits and the value of their on-balance sheet ABS. If you tell people it’s worth par often enough, loudly enough, maybe it will be…

They have some unusual animals in Regent’s Park at the moment… October 13, 2007 at 6:02 pm

…and some of them are even more rare than buyers in the ABCP market. That however, may be about to change.

The proposal apparently (the details are sketchy) is for a group of banks to set up a mega-SIV. This new vehicle will acquire the mortgage assets now held by some existing SIVs and conduits. The range of participants is unclear – Citi, with over $100B in conduits, is apparently leading the deal structuring, with JPMorgan interested in selling the new paper. The basic idea is that having a vehicle with a more diverse range of assets will avert the need for many banks to sell their existing conduit assets causing a crash in the RMBS market. Things are not exactly going well there as it is, as you can see from the recent price action on the ABX Home Equity BBBs (this graph is for the 07-2s):


(Graph from Markit via Calculated Risk. This is pretty good on the ABX if you need some background.)

The credit enhancement for the new vehicle hasn’t been made public thus far: one structure might be for all the contributing banks be jointly and severally liable for some bottom tranche, followed by a layer of seller-specific credit enhancement. The proposal is apparently to be dubbed M-LEC, for master liquidity enhancement conduit.

In this context it occurs to me to wonder why holding assets off balance sheet in conduits have such a preferential capital treatment compared with on balance sheet credit enhancement. To see this, consider the following two trades: 1. A bank sells a diverse $500M portfolio of assets into a conduit, retains a $10M seller’s interest, funds by issueing three month ABCP, and writes a back-up liquidity line; 2. A bank holds the assets on balance sheet and buys a three month credit derivative on losses in excess of $10M, rolling it as it expires.

In both cases the bank is exposed to losses between 0 and $10M but not above. In 1., it has to fund the assets if the ABCP market is disrupted, whereas in 2. it knows that it has to fund the assets in all conditions and hence can lock in term funding. Therefore arguably 2. is less risky than 1., and certainly not riskier. But you can guess which situation has the higher regulatory capital, can’t you?

Update. The plan is now out. Or, at least, the intention to come up with a plan that may lead to the MLEC is out. I wonder how they are going to value the assets the MLEC will wave in…

How much? September 13, 2007 at 8:44 pm

From today’s FT:


Continued high overnight interest rates forced the Bank of England to offer £4.4bn additional cash to commercial banks on Thursday morning, in an effort to normalise the money markets.

A decent sized conduit or SIV is £5B so the bank’s extra liquidity is less than one conduit’s worth. Is anyone else surprised how relatively small the bank’s offer is? Personally I think they are doing an excellent job in not rescuing the imprudent, but I wonder if £4B is significantly different from zero.