What You Need to Know About SIVs

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What is a SIV? Does the SEC regulate SIVs? -- R.P.

Recently, everyone's been talking about SIVs. So what are they all about and what's the big deal?

The letters S-I-V stand for structured investment vehicle. SIVs have been in the news a lot in connection with the credit crunch and subprime mortgage blowup.

SIV Defined

An SIV is a type of complex bond market investment, which was originally created to help banks finance low-risk assets such as credit card loans, explains Ken Hackle, managing director of fixed-income strategy at Greenwich Capital in Greenwich, Conn.

To set up a SIV, banks borrow cash by selling commercial paper to investors and then use the proceeds to purchase bundles of high-quality loans. Commercial paper is like a Treasury bill in that investors buy it at a discount from its face value and expect to hold it for 30, 60 or 90 days, at which point the investor gets back the full face value of the note.

Historically, since the underlying assets of the SIV -- the credit card balances, home mortgages, car loans and student loans -- were relatively low-risk, they also had very low profit margins. And because of the low profitability relative to assets, banks wanted to keep the loans off their balance sheets , Hackle says.

Citigroup(C), Bank of Montreal(BMO) and HSBC(HBC) were just three of the big issuers  of SIVs.

The Rise and Fall of SIVs

Some bankers decided the low profit margins of SIVs were inadequate and looked for ways to boost returns . One way to do that was to buy riskier borrowings, such as home-equity loans . And for a while, it worked.

But then came this year's housing slowdown, thanks in large part to the emergence of problems with home loans made to borrowers with dodgy credit, the so-called subprime sector. As some borrowers stopped making their house payments, the asset-backed securities  holding the loans started to underperform. What were previously considered to be almost risk-free investments were turning out to be a lot more risky than first thought.

Typically, when the borrowing period for the commercial paper ends, the lender roll overs its funds and reinvests in the same product. But as the problems with subprime emerged, that process broke down.

"The investors got very concerned [about the subprime situation] and refused to roll over their investments," says Hackle.

SIVs and the Small Investor

Because SIVs and their underlying assets are very complex things, small investors aren't usually allowed to buy them.

"A lot of these vehicles are unregistered with the Securities and Exchange Commission and are primarily intended for sophisticated individual investors and institutions ," says Kingman Penniman, president of KDP Investment Advisors in Montpelier, Vt.

That means that SIVs can only be sold to so-called "qualified investors." In simple terms, qualified investors are funds run by specialized money managers  or individuals who are rich enough to be designated "qualified" (see institutional investor ).

But that doesn't mean small investors are immune to the problems that SIVs are having in the credit markets, Penniman says. That's because many money market mutual funds and exchange-traded funds  have bought SIVs as a way of boosting their yields , so providing better returns for their customers (see "Money Market ETF Not as Safe as It Appears" ).

To learn more about SIVs, check out these stories on TheStreet.com:

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