According to the Journal piece,
"SIVs need to find investors for $100 billion in debt coming due in the next six to nine months, even as ratings firms continue to come out with reports that lower the ratings of securities in moves that could further depress the value of SIV holdings."
Thus the targeted $100B size of the M-LEC fund proposed by the Treasury. The article further reports that SIVs have some $350B of assets, mostly in mortgage-backed structured finance paper.
Echoing my post of last week, in which I wrote,
"Let's consider what would happen if the M-LEC did not take off, and the SIVs had to wind down their investments.Some very specious assets would be sold at fire sale prices. Investors in the SIVs would be substantially wiped out. Some creditors of the SIVs, holding commercial paper, would be stiffed, too,"
The Journal opines,
"Besides tapping the superfund (M-LEC), SIVs are likely to re-structure their debt, wind down, or, in a worst-case scenario, become a dead SIV that can't pay debt investors."
Contrary to my friend's contention, in a conversation I reported here last weekend, that SIVs are levered 3-4:1, the Journal article says that most have only a 5% equity-like investment in 'Capital -notes.' This makes the leverage 19:1.
The Journal pieces continues,
"Capital-notes holders face two options: risk losing money if the SIV sells assets to the banks' fund at a loss, or try to keep the SIV going by buying more of its debt. In recent days, SIVs have been trying to persuade capital-notes holders to buy medium-term notes to fund the SIVs and protect their investments, people familiar with the matter say. Some capital-notes holders -- and SIVs -- say they are skeptical about the banks' plan, because selling assets at today's prices will require the SIV and the notes holders to recognize a loss on those investments.
The lead banks have provided little public guidance on their plans for the fund, leaving themselves open to criticism. Executives working on the fund see it not as a silver bullet but as one of several options open to SIV operators, according to a person familiar with the effort.
The plan would benefit a lead participant, Citigroup, because it is a large operator of SIVs. The SIV industry has become a key part of the U.S. economy, because the funds buy securities backed by mortgage loans to U.S. home buyers. The industry, at its peak earlier this year, totaled about 30 funds with $400 billion in assets.
The three banks have many issues to work out, according to people familiar with the situation. They need to figure out how participating banks would divide any profits or shoulder losses when the rescue fund is wound down, according to people familiar with the plan. They need to decide if participating banks will be ranked based on how much funding they provide, just as banks take lead and supporting roles in stock offerings."
These are some of the issues which I mentioned in my initial piece on this topic last week, providing more reinforcement for my views on this evolving financial services issue.
As a former Chase Manhattan corporate strategist, I can't but help muse about how these events have been triggered by the last decade's evolutions in commercial banking roles. As I wrote here, last month, concerning another article appearing in the Wall Street Journal,
"But a larger issue struck me in this piece. Maybe credit markets went too far in their evolution to total market pricing of credit and debt.
Commercial banks seem, after all, to have a few advantages that were unapparent in a consistently up-market.
Could it be that, rather than a uni-directional march toward market pricing and underwriting, credit markets are, in reality, about to swing between extremes? Moving from all-bank balance sheet valuation and warehousing, to heavily market-priced and securitized, and now back toward the original pole of bank-sourced and distributed credit instruments?
It's not something I've read anyone else hypothesizing. Even I just assumed that banks had pretty much become a mere origination platform for credit.
Now, with this latest credit market debacle, the first since really heavily asset securitization of mortgages and corporate loans have kicked in, we are learning that there are market conditions under which non-banks may not be viable for very long, if they originate and/or hold volatile fixed income assets.
It's an interesting phenomenon. Who would have guessed that there was life in the old commercial bank model, yet?"
The passage in Wednesday's Journal article citing the importance of the SIV sector, "at its peak....about 30 funds....$400 billion in assets," causes me to ponder how the three largest commercial banks- Citigroup, Chase, and BofA- and perhaps a few more, would have managed the mortgage assets on their own balance sheets a decade ago.
Back then, the largest banks built or bought large mortgage origination businesses, feeding into the banks' own large lending portfolios. The rise of securitization, with its liquidity and market-based risk pricing, made it economically feasible and sensible for the commercial banks to cede the portfolio lending business to a market of CMOs and, now, CDOs.
If the commercial banks had remained portfolio lenders, would this current SIV sector have reached $400B in assets? Or would the risk management functions of the banks have slowed as the mortgages began to decline in quality, hitting the sub-prime market? For example, one-time high-flying manufactured housing lender Green Tree Financial was rescued by an Indiana-based insurer, not a commercial bank.
As inept and stodgy as commercial banks can be, including their own prior mortgage lending problems which helped lead to the RTC creation to clean up the last housing finance mess, I think they perhaps exercise a bit more focused risk oversight than a widespread free market in CDOs.
While free financial markets more accurately price risk over time, they are prone, naturally, to excesses, as they swing from birth, to growth, to excessive growth, to default and contraction.
Hopefully, the long term response to this latest housing finance cycle won't be Congressional legislation which hamstrings the market with excessive and clumsy regulation. Given some time, it's likely that the market will provide its own blended solution of a return to portfolio lending by commercial banks, mixed with a modest re-emergence, in time, of securitized residential mortgage paper. And, next time, it's likely that investors will be more wary, and rating agencies will be more sanguine in the development and operation of their loss prediction models.
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