Thursday, October 18, 2007

M-LEC, In Brief with New Info

I had an opportunity to speak with some people on Wednesday that have been directly involved with Structured Investment Vehicles (SIVs).

After that discussion, and further review of published information, I thought it would be helpful to summarize what I know about M-LEC:

  1. The first thing that needs to be understood is that M-LEC is a proposal. There is an agreement in principal, but the lead banks are still looking for partners and have not settled (at least as reported) on the specific structure and how M-LEC would interact with the SIVs.

  2. I cannot stress this enough, but I have been assured that lenders to the SIVs have no legal recourse to the banks! There is no obligation for the banks to bail out the SIVs. There ARE lines of credit that were intended to provide liquidity, but they generally require that the banks would lend 10% of the SIVs' assets (and we don't know what, if any covenants there are related to these "back-stop" lines of credit). Even if the banks were to provide the backstop, they wouldn't be taking the SIVs' assets onto their balance sheet.

    That said, there are reputational and client relationship issues that might be judged to be important enough to justify one or more banks taking on the assets of related SIVs, despite their lack of obligation.

  3. Unlike what some have been saying in the blogosphere (and in at least one newspaper), M-LEC would be intended to solve one problem and one problem only - revive liquidity in the asset-backed commercial paper market. SIV commercial paper is held by, among others, money market funds that are not supposed to be taking risks with the capital that is provided to them. Should the SIVs start to default, the problem would quickly spread to other fixed-income, and probably equity, prices - perhaps removing a great deal of liquidity from the economy. That scenario would touch a LOT of Americans (and Europeans and Asians, etc.).

  4. News reports have been sketchy (as previously mentioned) on whether, and to what extent, the participating banks would guarantee the solvency of M-LEC. The original Wall Street Journal article implied that there would be a guarantee from the banks. The press release does not speak to that issue.

  5. M-LEC, if implemented, will give time for the SIVs to liquidate their assets, as necessary, in an orderly fashion. If nothing is done, there is a lot of fear as to what would happen.

My personal belief is that, without bank guaranties, M-LEC would have great difficulty surviving and/or providing effective relief to the commercial paper market.

I believe that, if the banks guarantee M-LEC's borrowings, then the plan could work. I don't know if the fund needs to be $80 billion, $100 billion, or some other amount.

I believe that, for investors to purchase the SIVs' debt, there needs to be a greater degree of confidence that the investors will be repaid. Without the banks standing solidly behind this "super" SIV, it is not clear to me how confidence could return to the marketplace.

Clearly, there is a lot that we do not know about M-LEC. Hopefully we'll find out more in the coming weeks.

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Palermo's Blog said...


What if the banks left the commercial paper holders to hang out and dry? Would anyone purchase CP from a CITI sponsored off-balance sheet entity? Now consider the $77 billion Citi has in liquidity facilities for SIVs (we think) and ABCP issuers. Citi can not leave CP purchasers holding the bag, whether the obligation is legal or not. It could be catastrophic for the bank.

Lawrence D. Loeb said...

Two things:

1. Not all of an SIV's capitalization comes from commercial paper. In fact, of the seven SIVs rated by Fitch, only 23% of asset capitalization comes from commercial paper. There are at least two layers of funding that would suffer losses before the commercial paper would be impaired (see§or_flag=10&marketsector=1&detail=).

2. It is unclear what reputational risk the banks would have should an SIV that they manage, or that is managed by their clients, would fail.

I recommend reading the Wikipedia explanation of SIVs as it gives a better understanding of what they are and how they are capitalized. I also recommend looking at the reports published by Moody's and Fitch on their websites.