In October 2007, the inventors of the structured investment vehicle (SIV), Nicholas Sossidis and Stephen Partridge-Hicks, faced a problem. The short-term commercial paper they had sold was coming due. The capital in their $57 billion hedge fund, called Gordian Knot, was locked up in long term investments and they needed more buyers to pay off the short term debt.
Years ago, two London bankers left Citigroup Inc. to set up a company specializing in a new kind of investment fund. They named their firm Gordian Knot Ltd., they said, because they liked the legend about Alexander the Great solving a complex knot by simply taking a sword to it.
More after the jump:
Now, the U.S. Treasury and the world's biggest banks are grappling with their own baffling knot: how to prevent the unraveling of an entire class of such funds -- called structured investment vehicles -- from turning into a financial and economic disaster.
For hedge funds such as Gordian Knot that managed SIVs (or SIV-Lites), it was becoming more difficult by the Fall of 2007 to find insurers to lay off their risk. Additionally, investors had become wary of buying their short term debt.
SIV-Lite vehicles tend to invest in high-reward, high-risk assets to make the short-term commercial paper they issue to fund their investment strategy more attractive. But the commercial paper traditionally pays out every 90 days, which means that if the appetite for such issuance disappears, a SIV-Lite can quickly face a liquidity crisis.
The market for asset-backed commercial paper, as this short-term funding is called, has dried up in recent weeks as investors have shied away from such potentially risky investments. Many of these vehicles are invested in the US sub-prime mortgage market, but a rise in mortgage defaults there has dramatically reduced the value of these assets. As a result SIV-Lite vehicles, along with many hedge funds, have found their access to new money cut off at the same time as the value of their assets is declining.
Without a continuous flow of investment, Gordian Knot's Sigma and other offshore-based SIVs needed to be restructured or else confronted liquidation.
Cayman-listed Mainsail and Golden Key are two of four so-called Siv-lites that hit the headlines in August when the credit crunch led to the collapse of the short-term commercial market. This in turn meant funds using the Siv model could no longer meet their short-term repayment obligations.
Among the hurdles faced was the reluctance of insurers to back the transactions with credit default swaps.
An earlier attempt to restructure Cairn’s fund, Cairn High Grade Funding I, had failed because it could not attract a counterparty on which to lay off some of BarCap’s risk. Sources said that BarCap had now obtained a credit default swap to protect its cash, should Cairn default on the loan.
SIV-lites are packages of asset-backed securities that are used as collateral to raise money in the commercial paper market. They are often leveraged by between 40 and 70 times.
Gordian Knot founders Sossidis and Partridge-Hicks traveled in October 2007 to Washington to meet with Citigroup, Bank of America and JP Morgan Chase to devise a solution to their credit problem. They came up with the "superfund", a debt rescue bid which would unwind the leveraged security investments.
Nicholas Sossidis and Stephen Partridge-Hicks, who invented the SIV and now run the biggest, a $57bn fund called Gordian Knot, were among those gathered in Washington to try to find a solution.
Citigroup, Bank of America and JP Morgan Chase - which also have quite a bit of exposure - decided to combine their efforts to stave off the next meltdown in an unprecedented show of unity. Now they are trying to raise as much as $100bn by the end of the year to support an orderly unwinding of the SIVs, in the hope that this will restore confidence in the debt markets. The fund has its own catchy name, the 'master liquidity enhancing conduit', or M-LEC for short.
They chose $100bn because it represents just less than 30 per cent of the $350bn in debt issued by SIVs coming due in the next six to nine months. If at least one third of that debt isn't serviced, they fear[ed], all hell [would] break loose.
Citigroup, the largest holder of SIVs, was able to obtain temporary financing, but only enough to make it through the end of 2007.
Yesterday, Citigroup executives said separately that they bought some time by securing $80 billion in financing through the end of the year. That provides some relief because Citigroup can avoid a fire sale of assets at distressed prices, but it is not a long-term solution for the bank or the industry. A greater amount of backup financing is needed.
So far, the banks agree on the larger goal: to restore stability and confidence to a vital pocket of the commercial paper market. They [were] concerned that if all 30 S.I.V.’s, which hold about $320 billion in assets, began selling securities at once, prices would plummet and lead to a lending freeze.
Not enough private capital was put forth to form a "superfund". By February 2008, financial chaos was on the horizon. The expected losses ($350 billion in the financial sector, $600 billion total) would be similar to the figures later used for Henry Paulson's TARP request.
It would take 10 months for Goldman Sachs to create a model for restructuring SIVs. Among the multibillion dollar investments with esoteric names such as Rhinebridge, Whistlejacket, Nightingale, Mainsail, and Golden Key, only 2 could be unwound.
Creditors of a $30 billion (£15.2 billion) finance company managed by Gordian Knot, the City investment firm, have called in Deloitte, the accountants, to advise them on recovering their cash amid fears that Sigma Financial may not be able to pay its debts.
Sigma has not run out of cash and, unlike most SIVs, does not have triggers that force it to wind up if the market value of its assets falls below a set point. However, it has $8.6 billion of debt maturing by September 30 and investors are thought to be worried about Sigma's ability to meet its obligations. On Friday analysts at Citigroup said that Sigma was "walking a tightrope" with its funding arrangements.
Deloitte worked with Goldman Sachs, the investment bank, for ten months to create a model for restructuring SIVs and has completed two: the $7 billion Cheyne Finance and $2.4 billion Rhinebridge. The accountancy firm is still working on restructuring Whistlejacket, a $7 billion SIV formerly managed by Standard Chartered, and the $1.9 billion Golden Key, which are not expected to be completed until autumn.
One of the SIVs which could not be unwound, Whistlejacket, was forced into receivership.
Credit market problems have forced Standard Chartered to call in the receivers at its structured investment vehicle (SIV), one of the more "toxic" products created during the recent financial services boom.
The specialist emerging markets bank was preparing to bail out the SIV it manages, Whistlejacket, with a $7.15bn (£3.67bn) funding line before a sudden collapse in the assets' value triggered yesterday's "enforcement event". Under the rules governing the SIV, a receiver has to be called in once the net asset value (NAV) halves.
About 40pc of Whistlejacket's assets are in debt issued by US, European and Australian banks, and 50pc in asset-backed securities. Confidence in both asset classes has been hammered by the sub-prime mortgage crisis, which has undermined faith in the banks' commercial paper and the quality of mortgage books.
Another SIV, Nightingale, had been insured by AIG who was forced to absorb the losses.
Insurance giant American International Group Inc. said Wednesday it is bailing out a $2.5 billion structured investment vehicle, or SIV. The AIG SIV, Nightingale Finance, is managed by AIG-FP Capital Management Ltd.
Vehicles such as Nightingale have struggled to raise financing since investors started shunning their IOUs in August, as concerns grew about potential defaults on the mortgage-backed securities that typically make up about a third of SIVs' portfolio.
Amidst the downturn, Gordian Knot’s Sigma was downgraded.
(Landsdowne House, headquarters of Gordian Knot Ltd.'s Sigma Finance Corp, in Berkeley Square, London - Chris Ratcliffe/Bloomberg News)
Gordian Knot Ltd.'s $40 billion Sigma Finance Corp. had its Aaa credit rating cut five levels by Moody's Investors Service as the value of its assets fell, increasing the risk the credit fund may have to be wound down.
Moody's downgraded Sigma's long-term debt to A2, the ratings company said in a statement today. The investment company's short-term debt rating was lowered to Prime-2 from Prime-1. The downgrades affect $23 billion of debt.
Sigma is the last and largest of the companies that financed themselves in the short-dated commercial paper markets to buy longer-dated assets. The so-called structured investment vehicles, or SIVS, were shut out when investors shunned all but the safest government securities because of contagion from the collapse in subprime mortgages.
By Fall, after the collapse of Lehman, Gordian Knot’s Sigma Finance Corp was forced to liquidate. Lenders terminated their repossession agreements, issued a notice of default and seized the fund’s assets.
The latest wave of financial turmoil has crippled $27 billion London-based investment fund Sigma Finance Corp., raising concerns that a messy sale of its assets could weigh on wobbly markets.
In a sign of the repercussions of last month's demise of securities firm Lehman Brothers Holdings Inc., Sigma faced imminent liquidation Wednesday after a drop in the value of its investments, which included Lehman debt, forced it to default on its borrowing agreements.
The default will likely leave investors in some $6 billion of Sigma's own debt holding paper worth as little as 15 cents on the dollar, ...
Finally, the same company which spawned the SIV would help scoop up its remains. Following injections from the TARP, Citigroup bought out the assets and assumed the debts the faltering SIVs.
Citigroup Inc., the fifth-biggest U.S. bank by market value, agreed to acquire $17.4 billion of assets held by structured investment vehicles advised by the company.
SIVs, which Citigroup invented in 1988, emerged 15 months ago as one of the first major strains in credit markets rocked by record high foreclosures on subprime mortgages. Citigroup, the biggest manager of the funds, has reduced the assets of its SIVs from $87 billion in August 2007.
Update: Edited story and snipped passages after previously posted comments by ROGNM and dadanation on copyright concerns.