Two years after Eaton Vance brought the first structured investment vehicle backed by loans to the market, the firm is set to launch another later this year. Other firms are also now looking at variants, so-called SIV-lites, which can have four, five or six tranches, among other different characteristics.
"There is no question [there will be] more SIV and SIV-lites in 2007 that focus on corporate loans as a primary asset class. What I don't know is whether they will close by June or the end of the year and that is really influenced more by the clients," said Nik Khakee, director, structured finance at Standard & Poor's.
A SIV can be an attractive alternative to a collateralized loan obligation; most notably because of its low leverage. CLOs with their sometimes close to 10 to 12 times leverage, are very high compared to bank loan SIVs that are leveraged, but only about three to five times. Also, the operating companies of SIVs issue debt at LIBOR levels close to plus or minus two or three basis points as compared to a CLO where debt is issued at LIBOR plus 30 or 40 basis points. SIVs also enable long liquidation periods, so that in theory a manager may have a longer opportunity to cure a test violation.
Another advantage is the size. "A structured investment vehicle gives more flexibility in the leverage than a typical CLO and can be about $1 billion or higher," said Alexander Rekeda, head of structured credit at Mizuho Securities. A typical CLO can often be in the range of $300-500 million. Some SIVS backed by bonds can grow to be $5-10 billion, even upwards of $20-30 billion. Rekeda said Mizuho is working on a SIV but declined to discuss the specific structure.
SIVs also have multiple closings. Walt Shulits, v.p. at Eaton Vance who helped design the product, explained, "A lot of costs associated with a SIV are fixed costs so that as the size of the vehicle goes up, the expense ratio to the investor goes down, so rather than having CLO 1 and CLO 2 and CLO 3, they [the investor] can make multiple investments in the same structure and only monitor the same structure." He stressed it is important to note SIVs are targeted toward bond investors seeking investment-grade core fixed-income returns, while CLOs are structured to benefit the equity investor.
Khakee suggested there were two possible reasons why it has taken so long for SIVs backed by loans to come to market. First, SIVs are very popular in Europe, and only recently that market has begun trading loans in large volume, he said. The second reason he suggested, is that the Eaton Vance structure, "demonstrated the right trade off, which is lower leverage than a traditional SIV, in exchange for lower-rated assets." He explained other participants may have wanted to wait to see how that product fared before launching their own.
Eaton Vance launched the Eaton Vance Variable Leveraged Fund in 2005. According to a Moody's Investors Service new issue report released at the time, the fund can raise up to $4 billion. It says 98% of the loans must be senior secured and no more than 2% may be revolvers. Typical operating leverage "is expected to be less than 4 to 1, compared to existing structured investment vehicles that operate at leverage ratios above 10 to 1." The portfolio must meet a variety of limits with respect to rating, pricing and industry concentrations. SF Solutions is the sub manager and Deutsche Bank is the collateral agent. Shulits declined to comment about the existing fund or the new structure Eaton Vance is working on.
This year should see the emergence of the SIV-lite backed by loans. "No one has done a SIV-lite with loans," Khakee explained, but said S&P does have criteria ready to use if a firm does decide to do one. He said, "We have projects in house already for SIV-lites with loans....but it is premature to assume which structure a firm will chose." He explained a firm can decide whether it will do a SIV or a SIV-lite late in the process because it does not have a large affect on the ratings agency analysis.
There are a few differences between a SIV and a SIV-lite. According to Khakee, S&P uses a few characteristics to differentiate between the two. First, it assigns a corporate counterparty to SIVs, but does not to SIV-lites. Another difference is the capital structure; SIVs typically have a two or three tier layer capital structure, while SIV-lites can have four, five or six-rated tranches. Another difference is that in a SIV, capital is held against the possibility that the SIV will have to liquidate an interest rate derivative position and that counterparty might default. Whereas, in a SIV-lite, the ratings agency uses more traditional structured finance criteria; typically in the interest rate swap the counterparty is promising to replace itself upon a threshold.