As SIVs face judgement week in rolling over their short term debt, most will be presented with a stark choice: draw down on bank credit lines or sell assets.
The first of those two options varies in its usefulness from SIV to SIV. Conduits – which are SIVs run by and for banks – have committed liquidity lines to cover all their short term debt. They, at least, have the luxury of knowing they can pay off their debts without selling assets at a loss.
But non bank-run SIVs typically have a credit facility only capable of covering peak outflows for just one week in any given year. So once those credit lines are exhausted they’re right back were they were before. In their case, drawing down credit from banks is a bit like trying to stop arterial spray with an elastoplast.
Faced with this gloomy dilemma, Moody’s have added a new seduction.
In the Q&A session after a teleconference last week, the rating agency slipped in the announcement that it would be allowing SIVs to use repo financing in their debt structures, should they so choose.
Repos – repurchasing agreements – are essentially a super-senior form of debt. Rather than use assets as collateral for loans, repos literally sell the assets themselves. The assets are bought from the borrower and sold back for more at an agreed later date.
Naturally, of course, that has existing SIV note holders worried, because it subordinates them in the capital structure. If a SIV with repo financing went into defeasance – those repo assets wouldn’t be coming back. Investors were noticeably concerned at the end of Moody’s teleconference.
But as far as Moody’s are concerned, it doesn’t really matter, because it’s no different from selling the portfolio assets on the ABS markets to raise cash anyway. Henry Tabe, Moody’s EMEA structured finance team leader said:
The use of repurchase agreements may be a source of liquidity independent of the ABS market at a time when asset sales are difficult. Repos may well be a practical solution as asset quality in all SIV portfolios is still high and it is reasonable to expect that the haircuts required as protection by counterparties will be within what the SIV can provide through capital, thereby not weakening the portfolio available to support other senior liabilities.
But there are some big questions with SIVs using repo financing. CreditSights raise a couple in a report out Wednesday:
Firstly, what happens to the SIV’s net asset value calculations? NAV is calculated on the basis of a SIV’s overall portfolio value minus its existing senior debts, divided by existing capital. It is basically, therefore, a measure of the collateral available to capital note holders. Selling assets would ordinarily have to be accompanied by a decrease in the number of a SIVs capital notes – otherwise the NAV would drop, and could trigger a Major Capital Loss test, and a forced wind-down. A repo will sell SIV assets, albeit on the understanding that they’ll be sold back. So where does that leave the NAV?
Secondly, not only will repo financing leave SIV capital note holders with less collateral – but poorer quality collateral too, since repos will take out the most highly rated assets in the SIV portfolio. According to CreditSights:
Repo counterparties will have first claim on the collateral posted in the repo. And because troubled SIVs are likely, because of the haircut limit on repos, to post higher-quality collateral in the repos, senior note holders may end up with not only less collateral backing the SIV program, but with a collateral pool diluted in quality.
Taking those unknowns into account, it’s hard to see repo financing enamouring institutions to the idea of investing in SIV paper. Rather than solve the current crisis in the commercial paper market, repo financing could well just underscore the problem which is creating it: fear.