Chunky diamonds may be a girl’s best friend. But for banks they can be anything but.
HSBC on Monday confirmed that its SIV troubles runneth over, onto the bank’s balance sheet. In order to avoid a forced liquidation of the vehicles, HSBC is restructuring the two large SIVs it manages: Cullinan, named after the largest diamond in the world, is the biggest SIV out there, while Asscher (named after the brothers who cut the Cullinan diamond) is the smaller of the pair.
Together they add up to $45bn in assets - which will now be consolidated onto the HSBC balance sheet. The funding, whereby HSBC will back new vehicles with a 100 per cent liquidity facility, or with term financing, will add up to an expected $35bn.
Big numbers. But the restructuring, through which senior debt holders of Cullinan and Asscher will be repaid as their debt falls due with the opportunity to reinvest in the new vehicles, should allow the SIVs to operate without value triggers which have the “potential to restrict Cullinan and Asscher’s investment and operating flexibility.”
With the commercial paper market gummed up since the summer, SIVs have struggled to fund themselves - a problem that HSBC says is not likely to find a “near term resolution.” The other problem is that declines in asset values have left these vehicles facing NAV or market value triggers that would put them into a restricted state of operation.
The latter seems to be the more immediate problem for HSBC. The bank says that both its SIVs are funded beyond the end of the year, with Asscher funded to April 2008. In terms of their asset value, Asscher, back at launch in January, was intended to have about about 10 percent of its portfolio invested in triple-A cash CDOs, with about 40 percent in residential mortgage-backed securities. Not a great place to be.
Across the two, said HSBC on Monday, credit quality is on average at the Aa1/AA+ level and there’s been no downgrades of securities held to date. But the market has gone cold on mortgage-linked securities right up the ratings spectrum.
Shares in HSBC took a tumble earlier this month as speculation grew that the bank would be hit by SIV woes. Panmure analyst Sandy Chen then issued a sell recommendation on fears that the bank would have to consolidate the troublesome two.
Other SIVs have been hamstrung by declining NAVs. But, as we noted earlier this month, HSBC has kept its portfolio tests under wraps.
The primary concern was that in taking its SIVs on balance sheet, HSBC would have to take on board the losses on their investments.
That is not the case - yet. Investors in the vehicles are left with with underlying risk in the asset portfolios. So, the bank says:
As existing investors will continue to bear all economic risk from actual losses up to the full amount of their investment, HSBC expects no material impact to its earnings. HSBC also expects limited impact on regulatory capital requirements because of this first-loss protection.
The market took it all in its stride. HSBC shares held flat in trade on Monday.
