What are SIV's?

John answered one year ago …

Ethan First I must say that I believe you already know the answer to this but!

A structured investment vehicle (SIV) is a fund which borrows money by issuing short-term securities at low interest and then lends that money by buying long-term securities at higher interest, making a profit for investors from the difference. SIVs are a type of structured credit product; they are usually from $1bn to $30bn in size and invest in a range of asset-backed securities, as well as some financial corporate bonds. A SIV has an open-ended (or evergreen) structure; it plans to stay in business indefinitely by buying new assets as the old ones mature, and the SIV manager is allowed to exchange investments without providing investors transparency / the ability to look through to the structure.

The risk that arises from the transaction is twofold. 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 the short term securities that the SIV has sold. Second, there is a liquidity risk, as the SIV borrows short term and invests long term; i.e., outpayments become due before the inpayments are due. Unless the borrower can refinance short-term at favorable rates, he may be forced to sell the asset into a depressed market.

An SIV may be thought of as a virtual bank. It borrows money using commercial paper (CP), which it traditionally issues close to the interest rate of LIBOR. It then uses the money to purchase bonds - effectively lending it out much as a bank would provide loans. The bonds usually selected by an SIV are predominantly (70-80%) Aaa/AAA rated Asset-Backed Securities (ABS) and Mortgage-Backed Securities (MBS) and hence the SIV is effectively providing the funds for mortgages, credit cards, student loans and similar products. An SIV would typically earn around 0.25% more on the bonds than it has to pay to the CP. This difference represents the profit for the SIV which will be paid to the capital note holders and the investment manager. The capital note holders are the "first loss investors" in that if any of the bonds purchased default, the capital note investor will lose his investment before the CP investors.