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GLGi: Structured Investment Vehicles (SIVs)

Jay Eisbruck

© 2007 Gerson Lehrman Group Inc., All Rights Reserved

Council Member Biography

Jay Eisbruck was the Managing Director of Moody’s Asset-Backed Finance Group, until November 2007. Jay had worked with Moody's since 1991 managing the credit analysis of all non-residential mortgage Asset-Backed Securities. During this time Mr. Eisbruck analyzed the quantitative, qualitative, structural, and legal risks of over 70 different asset classes including whole business securitization, reverse mortgages, credit cards, autos loans, intellectual property, insurance-related assets, and aircraft leases. He currently is focusing his efforts on aiding the development of new assets. Mr. Eisbruck also contributed to a number of articles on structural innovations and general trends in the asset-backed market. His article on the rating approach to intellectual property assets was included in the Wiley and Co. publication, “From Ideas to Assets,” Mr. Eisbruck earned both a MBA in Finance and a B.S. in Economics from New York University’s Stern School of Business, where he was a Racoosin Scholar.


Topics

► What is a SIV?

► How are they rated?

► What went wrong?

► Future outlook

► How are structured transactions purchased by SIVs rated?


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An Introduction to An Introduction to Structured Investment Structured Investment VehiclesVehicles

Presentation by Jay EisbruckPresentation by Jay Eisbruck

AgendaAgenda

What is a SIV?What is a SIV? How are they rated?How are they rated? What went wrong?What went wrong? Future outlookFuture outlook How are structured transactions How are structured transactions

purchased by SIVs rated?purchased by SIVs rated?

Part 1-What is a Part 1-What is a Structured Investment Structured Investment Vehicle?Vehicle? SIVs are investment vehicles that fund a SIVs are investment vehicles that fund a

diversified portfolio of assets by issuing:diversified portfolio of assets by issuing:– Commercial paper (CP)Commercial paper (CP)– Medium term notes (MTNs)Medium term notes (MTNs)– CapitalCapital

Generate yield on portfolio by managing:Generate yield on portfolio by managing:– Credit risks (Aa vs. Aaa/P-1)Credit risks (Aa vs. Aaa/P-1)– Liquidity/funding risksLiquidity/funding risks

Exhibit characteristics of both structured Exhibit characteristics of both structured transactions and operating companies transactions and operating companies

HistoryHistory

First SIVs created in late 1980s-Alpha First SIVs created in late 1980s-Alpha and Beta Finance Corps created by and Beta Finance Corps created by CitibankCitibank

Sophistication grows over time Sophistication grows over time – Dynamic capital structuresDynamic capital structures– Alternative liquidityAlternative liquidity– Synthetic exposuresSynthetic exposures

To date approximately 36 SIVS have To date approximately 36 SIVS have been launched including 6 SIV-Litesbeen launched including 6 SIV-Lites

As of August 2007 SIVs held over $400 As of August 2007 SIVs held over $400 billion of assets (Largest $55 billion)billion of assets (Largest $55 billion)

StructureStructure

Set up to be bankruptcy remoteSet up to be bankruptcy remote Established in beneficial tax jurisdiction Established in beneficial tax jurisdiction

(Cayman Islands, Jersey)(Cayman Islands, Jersey) Can issueCan issue

– Euro CPEuro CP– US CPUS CP– MTNsMTNs– Subordinated debtSubordinated debt– EquityEquity

SIV investments run by managerSIV investments run by manager– Operating manualOperating manual

Typical SIV StructureTypical SIV Structure

SIV Manager

Custodian

Derivative Counterparties

Liquidity Providers

SecurityTrustee

SIV Board of Directors

AssetsSenior

Liabilities

CP & MTNInvestors

CP & MTNDealers

Issuer and Paying Agents

Capital Note Investors

Capital

SIV

Source: DerivativeFitch

The Asset PortfolioThe Asset Portfolio

Guidelines set to maintain senior Guidelines set to maintain senior and sub ratingsand sub ratings– Limits on individual assetsLimits on individual assets– Limits on portfolio assetsLimits on portfolio assets– Limits on unrated assetsLimits on unrated assets– Hedging with investment grade Hedging with investment grade

counterpartiescounterparties

Sample Asset Sample Asset GuidelinesGuidelines

Additional concentration limits are imposed dynamically by the capital structure.Additional sublimits are in place for investment in Structured Finance assets.Furthermore, there are limits in place to address the remaining maturity of assets andlimit exposure to single transaction servicers.

− Minimum Rating Composition:Aaa 40%Aa3 to Aaa 50%A3 to Aaa 80%Baa3 to Aaa 95%Ba3 to Aaa 100%

− Maximum Obligor Group concentration is expressed as function of its rating:Aaa 10%Aa 8%A 4%Baa 2%Ba 1%

− Country LimitsUnited States of America 100%Other countries with a Rating of Aaa 50%Other countries with a Rating of Aa 25%Other countries with a Rating of A 10%Other countries with a Rating of Baa 5%Other countries with a Rating of Ba or lower 3%

− Sector LimitsFinancial 75%Structured Finance 100%Sovereign 75%Corporate 50%

Source: Moody’s Investors Service

Capital SufficiencyCapital Sufficiency

Matrix approachMatrix approach– Fixed guidelinesFixed guidelines

Simulation approachSimulation approach Marking to marketMarking to market

– Max daily/Min weeklyMax daily/Min weekly– Various pricing sources, described in Various pricing sources, described in

manualmanual

LiquidityLiquidity

Sized to cover maximum net Sized to cover maximum net outflows in fixed periods over next outflows in fixed periods over next 365 days365 days– 1, 5 day tests fully covered by backup 1, 5 day tests fully covered by backup

liquidity (Typically 5-10% of outstanding liquidity (Typically 5-10% of outstanding senior debt)senior debt)

– 10, 15 day test covered by backup 10, 15 day test covered by backup liquidity and highly liquid assetsliquidity and highly liquid assets

If tests failed vehicle can go into If tests failed vehicle can go into enforcement and assets liquidatedenforcement and assets liquidated

Role of the ManagerRole of the Manager

InvestmentInvestment– Determining what investments to buy and Determining what investments to buy and

sellsell FundingFunding

– Need to maintain access to capital marketsNeed to maintain access to capital markets Operational supportOperational support SystemsSystems ReportingReporting

– At least weeklyAt least weekly

How are Ratings How are Ratings Maintained?Maintained? Portfolios managed within pre-Portfolios managed within pre-

agreed limitsagreed limits Maintain sufficient liquidityMaintain sufficient liquidity Effectively eliminate interest rate Effectively eliminate interest rate

and currency risksand currency risks Frequent mark to market of assets Frequent mark to market of assets Procedures for controlled wind-Procedures for controlled wind-

down if necessarydown if necessary

Moody’s Rating Moody’s Rating RationaleRationale The eligibility criteria, portfolio parameters and mark-to-market

procedures for assets purchased The minimum over-collateralisation requirement provided by Capital

Notes, which is calculated based on the mark-to-market of the asset portfolio and in accordance with various factors relating to the composition of the portfolio;

Interest rate and currency hedging requirements that limit exposure to a narrow tolerance range

Liquidity facilities, breakable deposits and certain highly liquid assets within the investment portfolio

The performance of the Manager including its ability to keep the SIV within the limits, manage the parameters of the SIV in a stable manner, and mitigate risks arising from adverse developments by proactive and reactive measures

The Restricted Operations operating state designed to protect the vehicle from further deterioration

The Restricted Funding operating state whereby the SIV is prevented from issuing further CP and MTNs and acts to repay outstanding senior debt as it becomes due.


Basic ApproachBasic Approach

Monte Carlo simulation approachMonte Carlo simulation approach SIVs calibrate their models to SIVs calibrate their models to

Moody’s Capital Model to achieve Moody’s Capital Model to achieve ratingsratings

Based on historical dataBased on historical data– Rating transitionsRating transitions– CorrelationsCorrelations– Liquidation prices and timingLiquidation prices and timing

Manager quality ratingManager quality rating

What Went Wrong?What Went Wrong?

Through August 2007 performance was Through August 2007 performance was strong so flexibility increased (SIV-Lites)strong so flexibility increased (SIV-Lites)– Market grew quicklyMarket grew quickly

Downgrades in subprime mortgage Downgrades in subprime mortgage market and CDO marketmarket and CDO market– Leads to loss of confidence in structureLeads to loss of confidence in structure

Inability to roll maturing CP and MTNsInability to roll maturing CP and MTNs Inability to liquidate assets at sufficient Inability to liquidate assets at sufficient

priceprice

SIV HoldingsSIV Holdings

Holdings drop from $400 billion to Holdings drop from $400 billion to $300 million$300 million

NAVs drop from over 100% in July NAVs drop from over 100% in July 2007 to 53% at November 30.2007 to 53% at November 30.

Leverage increases from 15x to Leverage increases from 15x to 18x18x

Types of assets vary from SIV to Types of assets vary from SIV to SIVSIV

Assets Under Assets Under Management Management (approx $ (approx $ Bil)Bil)

050

100150200250300350400450


SIV Asset Sector SIV Asset Sector Composition Composition (as of 10/07)(as of 10/07)

Commercial Banks29%

Prime US RMBS11%CBO/ CLO

12%

Subprime RMBS5%

Non-US RMBS9%

ABS12%

CMBS7%

Other7%

Insurance/Monolines

8%


SIV Rating SIV Rating CompositionComposition(as of 10/07)(as of 10/07)

Aaa63%

A4%

Baa or Below1%

Insurance/Monolines

8%


Rating Actions to DateRating Actions to Date

Over $100 Billion of securities downgradedOver $100 Billion of securities downgraded Five senior notes of SIVs downgraded nine Five senior notes of SIVs downgraded nine

others under reviewothers under review All six senior notes of SIV-lites downgradedAll six senior notes of SIV-lites downgraded Vast majority of capital notes downgraded, Vast majority of capital notes downgraded,

most to Caa or below most to Caa or below Stresses updated to reflect market Stresses updated to reflect market

conditionsconditions

Implications on BanksImplications on Banks

Holders of capital notes suffer Holders of capital notes suffer losseslosses– Lack of transparencyLack of transparency

Liquidity obligationsLiquidity obligations– Relatively manageableRelatively manageable

Support SIVSupport SIV– Not obligated but expected to do soNot obligated but expected to do so– Citibank downgradedCitibank downgraded– Other banks in better positionOther banks in better position

Restructuring Restructuring InitiativesInitiatives Attempt to create Super-SIV failsAttempt to create Super-SIV fails Sponsor provides 100% liquiditySponsor provides 100% liquidity Sponsor wraps senior debtSponsor wraps senior debt

– Back on balance sheetBack on balance sheet Use of repo agreementsUse of repo agreements Capital notes exchanged for slice of Capital notes exchanged for slice of

asset portfolioasset portfolio– Allows investor to avoid recognition of Allows investor to avoid recognition of

losseslosses

Future Outlook for Future Outlook for SIVsSIVs Next wave of rating actions Next wave of rating actions

awaiting results of restructuringawaiting results of restructuring Existing portfolios will wind downExisting portfolios will wind down

– Speed will depend on recovery of Speed will depend on recovery of asset pricesasset prices

Unlikely to see new SIVs for near Unlikely to see new SIVs for near to medium termto medium term

New structure could be developedNew structure could be developed

SIV Refinancing SIV Refinancing ScheduleSchedule($ Bil)($ Bil)

0

5

10

15

20

25

30

35

Dec-0

7

Jan-

08

Feb-

08

Mar

-08

Apr-08

May

-08

Jun-

08

Jul-0

8

Aug-

08

Sep-

08

Oct-0

8

Nov-0

8


How are structured How are structured transactions purchased by SIVs transactions purchased by SIVs rated?-Part 2rated?-Part 2

Asset credit quality analysisAsset credit quality analysis– To what extent will the assets pay as To what extent will the assets pay as

promised?promised? Structured cash flow analysisStructured cash flow analysis

– Who gets that cashflow?Who gets that cashflow? Legal AnalysisLegal Analysis

– Can other investors make a claim on Can other investors make a claim on that cashflow?that cashflow?

Asset Credit AnalysisAsset Credit Analysis

Assessing the extent to which the Assessing the extent to which the loans pay as promisedloans pay as promised– Expected lossExpected loss

Analyze industry, originator, Analyze industry, originator, particular poolparticular pool

Analyze origination, underwriting, Analyze origination, underwriting, servicing, collections policies and servicing, collections policies and strategiesstrategies

Many Types of Many Types of Securitized AssetsSecuritized Assets Residential MortgagesResidential Mortgages Home equity loansHome equity loans Commercial mortgagesCommercial mortgages

Auto leasesAuto leases Equipment leasesEquipment leases Aircraft leasesAircraft leases Insurance receivablesInsurance receivables Franchise loansFranchise loans Music RoyaltiesMusic Royalties Tax liensTax liens

Credit card receivablesCredit card receivables Auto loansAuto loans Manufactured housing Manufactured housing

loansloans

Student loansStudent loans Healthcare receivablesHealthcare receivables Film receivablesFilm receivables Trade receivablesTrade receivables Timeshare receivablesTimeshare receivables Motorcycle loansMotorcycle loans Stranded utility costsStranded utility costs

Structural Cashflow Structural Cashflow AnalysisAnalysis Allocation of cashflows among Allocation of cashflows among

investors, credit enhancement investors, credit enhancement providers, and originatorproviders, and originator

Allocation of credit losses on Allocation of credit losses on underlying assetsunderlying assets

TriggersTriggers Availability of credit enhancementAvailability of credit enhancement

Legal AnalysisLegal Analysis

Can other creditors claim Can other creditors claim cashflows?cashflows?

Bankruptcy-remotenessBankruptcy-remoteness– Remote from effects of originator’s Remote from effects of originator’s

bankruptcybankruptcy– Remote likelihood of “issuer’s” Remote likelihood of “issuer’s”

bankruptcybankruptcy

Monitoring RatingsMonitoring Ratings

Compare actual performance to Compare actual performance to expectationsexpectations

Determine cause of deviationDetermine cause of deviation– Short term or long termShort term or long term

Reset expectationsReset expectations Take rating action if necessaryTake rating action if necessary

Questions and Questions and AnswersAnswers

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