Structured Investment VehicleJohn Earla
Structured Investment Vehicle
A structured investment vehicle (SIV) is a type of special-purpose vehicle that purchases long-term bonds and other fixed-income securities and pays for them with short- to medium-term instruments like commercial paper. Citibank founded the first SIV, Alpha Finance Corporation, in 1988, and since then, numerous SIVs have been set up by specialist fund managers and banks.
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What is a Structured Investment Vehicle?
A structured investment vehicle is also known as conduits. A non-banking financial entity is set up and designed to collect the pool investments assets that can give profits in the differentiation on the credit spreads or Interest rates between the Long-term Structured products like ABS (Asset back Securities), MBS (Mortgage back Securities), etc. and short-term debt. They could borrow money at 2.5 percent in the money market and then invest it in structured products for a 4.5 percent return and a 2% gain. The bank has no credit risk or contributions to the Structured Investment Vehicles (SIVs) or other vehicles because it does not own them.
How is SIV is Different From SPV:
A structured investment vehicle is a non-banking finance company that is designed to earn a profit of the credit spread between its Short-term debt and a long-term asset like a traditional bank. Before the market crash in 2008, the SIV is so much popular globally.
Securitizations offer a good quality high number of assets to the investors by their structure to get out from the Bankruptcy frisk from the originator. To ensure that the assets achieve the bankruptcy remoteness, it is essential to move them out of the balance sheet of the Originator and park them with another independent entity. An SPV is created to purchase the assets from the Originator and issue securities against these assets. The structure of the SPV provides comfort to the investors that they are investing in a pool of assets that are on behalf of the SPV and do not have any credit exposure of the Originator. The SPV is usually a capitalized vehicle whose ownership and management are independent of the Originator.
For example, the housing loan banks, or high net worth retail banks have issued 100crores of mortgages to the house owners, for cash, the investment banking division must create and sell 100 crores of IOUs (‘mortgage-backed securities’) to an SIV- a separately created entity.
The SIV raises the capital to buy these bonds (mortgage-backed securities) by selling 1000crores of its own IOUs to other investors. These IOUs often are in the form of short-term debt like ‘commercial paper’ because the SIV knows that it will gain more interest from the Long-term debt (mortgage-backed securities) so they can pay to the Lenders or Investors of commercial papers. The SIVs are refinancing and create new short-term debt.
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Role in The Subprime Crisis:
First, the SIV was created by Citigroup in 1988, where large investors in securitizations are interested in the US subprime mortgages, while other SIVs had no exposure to these products that are linked to the Financial and economic crisis in 2008. There were only 7 SIVs on or before 2000 the SIV sector tripled in assets between 2004 and 2007 and at their peak just before the financial crisis in mid-2007, there were about 36 SIVs with assets under management more than $400 billion. By October 2008, no SIVs were active.
Structured investment vehicles are not regulated properly than other investment vehicles and are maintained off the balance sheet by large financial institutions, such as commercial banks and investment houses. So, these activities do not have any impact on the assets and liabilities of the bank. SIVs have earned much attention during the mortgages and subprime crisis of 2007; tens of billions in the value of off-balance sheet SIVs was written down or placed into receivership as investors fled from subprime mortgages related assets. After the end of the 2008 crisis, there are no SIVs presented actively.
After the 2008 financial crisis, the Structured products are like SIVs, and SPVs are restructured and made some regulations for the benefit of the investors and not fall into the Bankruptcy Risk.
Author: John Earla
About Author: Currently pursuing Financial Risk Management from GARP(US) and completed Graduation in B.Com computers. John is interested in finance and Risk Analysis.