# SIV pain resurfaces through ratings

The review was prompted by the deterioration in the liquidity environment in the underlying assets in the portfolios of these structures, which were set up to take advantage of the arbitrage between the long-term maturity of their underlying assets and the availability of cheap short-term funding through commercial paper and medium-term notes.

“The downgrades and recent rating actions have been taken as a result of dramatic spread widening and the consequent pricing effects,” said Henry Tabo, managing director at Moody’s in London.

That pricing disclocation has amounted to a decline of 1.6% in the price of financials over the last two weeks alone, and a decline of 22% in the price of collateralised debt obligations based on asset-backed securities (CDOs of ABSs).

“The price decline in assets that are stable from a credit perspective has meant that liquidity had once again dried up in the two weeks preceding the downgrades,” noted Paul Kerlogue, a senior credit officer at Moody’s in London.

The move has largely been determined by changes to the rating methodology applied to these assets, as a result of unprecedented spread movements across in these assets.

“We had also adjusted our methodology to apply further haircuts of 10-15% to net asset values to generate price distributions,” said Tabo. “The pricing paradigm has shifted and our asset haircuts are influenced by the price declines we have seen since the end of July.”

The deteriorating situation in spreads in financials, representing 38% of SIV portfolios according to Moody’s, is a further blow to a sector already reeling from the collapse in ABS investor sentiment over the second half of this year. That has prompted managers of these vehicles to seek to restructure these vehicles as the prospect of forced asset sales in the wake of failed market value tests looms.

Cairn Capital is the only manager to have successfully restructured such a vehicle, removing the market value tests and creating a cashflow term funding structure to replace a failed SIV-lite structure, Cairn High Grade Funding. Others, such as Solent Capital and Cheyne Capital, have since failed in restructuring attempts as tensions between the interests of the various noteholders become an increasingly difficult hurdle.

Dresdner Kleinwort, meanwhile, has so far redeemed $17.5 million of notes in its K2 SIV by the use of vertical slicing. This technique involves term note investors being offered their money back. In return, they have to buy the percentage of the portfolio covered by their note holding, and transfer those assets to their balance sheet. This transfer of assets avoids the vehicle having to sell assets in a depressed market. That method has also been used by Standard Chartered in their Whistlejacket SIV, involving a transfer of$1.68 billion of assets early this month.

Others, such as HSBC and Rabobank, have taken the SIV assets on balance sheet, effectively negating the market risk associated with the off-balance-sheet nature of traditional SIVs. HSBC offered investors the chance to transfer their investment in the Cullinan and Asscher SIVs to other less sensitive vehicles on November 26. West LB and HSH Nordbank have meanwhile been forced to extend extra liquidity lines to their vehicles, as the lack of investors in the short-term paper has meant extra support is needed.

Moody’s responded to the changing situation by extending its review period for SIVs. This was “due to the receipt of new, material information about possible changes to these issuers' operations,” said a report released by Moody’s on Wednesday December 5. “In some cases, SIV managers are contemplating changes to their management strategies with the objective of reducing market value risk for senior debt investors, while in other cases SIV managers are implementing restructuring proposals that would provide more protection to senior debt holders.”

The rating agency added that it will announce the results of its review of the individual vehicles as they occur, rather than reporting the results of the review wholesale. Most action will be taken within a two-week period.

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The week on Risk.net, July 14-20, 2018