Goldman’s Super-SIV: Some Questions

Anousha Sakoui and Gillian Tett of the FT have an excellent overview of the mechanics of Goldman’s ‘Cheyne SIV Restructuring Model’:

“- Assets held by the SIV will be auctioned to establish a transparent cash value. About seven investment banks will be invited to bid on buckets of assets as well as the whole portfolio. Goldman Sachs will provide a bid at market price, ensuring the auction does not fail. However, the receivers can delay the auction if market conditions deteriorate.

– Deloitte, the receivers, will sell the portfolio to Goldman Sachs at the price determined by the auction, a process which leaves behind the claims of the junior creditors.

– Goldman Sachs will offer senior creditors four options to chose from ahead of the auction. They can: 1) accept a cash pay-out, potentially for less than the face value of their original investments; 2) use the cash to take a pro-rata chunk of the assets to manage themselves; 3) buy zero coupon notes issued by Goldman Sachs (with the same credit rating as Goldman Sachs); or 4) invest in a new vehicle holding Cheyne’s old assets by buying pass-through notes.

– Goldman Sachs will then create this new vehicle, called Gryphon, which will issue pass-through notes (PTN) to investors – and then use these proceeds to acquire the assets from Goldman Sachs.

– Gryphon will then manage the old Cheyne assets. If all goes well, the investors will enjoy the benefit of any recovery in the asset values. However, Goldman Sachs has exclusive rights to restructuring Gryphon.

– The sale of assets to Goldman and Gryphon, and the issue of notes, all happens in one day.”

As we know, an SIV’s assets composition is typically as follows: a mix of highly rated (usually ‘AA’ or higher) financial assets consisting of financial institutions debt (industry average 50%), structured finance assets (industry average 46%), sovereign debt (industry average 2%) and others (industry average 2%). The liabilities consist of a combination of capital notes (CN; 8%) (=equity) in addition to commercial paper (CP; 14% in December 07 down from 23% in September 07) and medium-term notes (MTN = senior liabilities; ; 66%). Dividing the sum of liabilities by the capital note share implies a leverage ratio of around 12 times. By Q1 2008, outstanding SIV assets have declined from $400bn in July 2007 to $300bn.

Given this data, the restructuring plan raises several questions:

– The credit quality of SIV assets declined further since December, when the ‘Super-SIV’ plan was shelved due to banks’ asymmetric exposures and the looming threat of forced fire sales– remember that SIVs operate with limited committed credit lines which is why the structure’s independent rating is subject to strict investment, asset valuation and funding/liquidity tests. If breached, these tests may ultimately trigger the unwinding of the structure (UBS suggests the first threshold is at NAV =70 cents on the dollar.) Will the auction price reflect the real value of these assets?

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Would this plan be viable without Goldman’s access to the Fed’s primary dealer credit facility or the TSLF? The scenario of Goldman buying up at a discount Cheyne assets and restructure them at its own discretion in order to swap them with the Fed (or the ECB via intermediaries) is not far fetched. Remember that before granting investment banks access to the Fed’s discount window, the Fed waived regulation W in order to allow commercial banks to extend more credit to cash-strapped investment banks. Investment banks are now in a position to do the same with off-balance sheet vehicles. Moreover, there is a consensus in the marketplace that SIVs are not likely to survive without credit lines and at realistic valuation levels.

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