Lack of diversification killed the SIVs
Just because rating agencies have been the target of sustained criticism for months doesn’t mean that there is any compelling reason to stop. Moody’s has been widely ridiculed for publishing a report entitled “SIVs: an oasis of calm in the sub-prime maelstrom” on July 20, but nearly a full month later (on August 16), Standard & Poor’s was reassuring the market that “SIVs are weathering current market disruptions”. Little more than two weeks later all the agencies were announcing negative rating watches and downgrades to SIV structures like there was no tomorrow.
And there is no shirking responsibility for this one. Closer inspection of the first two SIVs to come under pressure (Cheyne Finance and Rhinebridge plc) revealed that the much-vaunted asset diversity that these structures were supposed to embody was simply not there. Indeed, the figures are quite shocking: Rhinebridge had nearly 75% of its assets in US home equity loans and sub-prime. Even the Cheyne vehicle was approaching 50% sub-prime. SIV portfolios were never meant to be this concentrated – a look at the earlier vehicles shows that 75% was more likely to be the limit on exposure to the entire ABS market – not one (high-risk) sector. The mantra of the industry is that the vehicles operate “within strict leverage, credit quality and diversification limits” but allowing 75% sub-prime exposure cannot be described as strict by any stretch of the imagination.
Having been astonishingly relaxed early on about the impact of an impending liquidity squeeze on these vehicles, the rating agencies are now watching SIV net asset values (the amount by which the market value of the assets exceeds senior debt, divided by capital) with increasing anxiety. Having been 102% at the beginning of June, average NAV was down to 85% by the beginning of September and falling fast. The early bath taken by SIV-lite structures revealed just what a good idea financing pools of overwhelmingly US RMBS assets via CP without unconditional liquidity support turned out to be, but that particular clanger was restricted to a tiny (0.3%) part of the ABCP market. And those were quasi-market-value CDOs, not operating companies that rely on continuous funding. Diversified pools are fundamental to the SIV concept, and by permitting vehicles to become as concentrated as they have, the agencies have done themselves – and the market – no favours. Anxious to be seen to be doing its job, Moody’s updated its modelling parameters on September 5 – immediately pushing three further SIVs onto creditwatch negative. The hope is that SIV wind-downs will be limited to these recent vehicles that have such highly concentrated asset pools but this is a situation that should never have been allowed to arise in the first place.
