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Shadow banking

(Article published in the Jul 9, 2008 issue of Manila Standard Today)  

We in the Philippines are both too unsophisticated to understand the scheme and too poor to be really scammed, so we have no SIVs.  Moreover, since the pooling of funds and investing the pool, separately from the banks own operations, is uniformly done under the banks’ trust license, the closet thing we have is at best SIV’s distant relative: the UITF as well as its forebear, the common trust fund, which came under the supervision right from day one of the regulator. Hence, in contrast with the SIVs, our bank-sponsored pools of investment never were, “unregulated,” nor, “underground”, nor even “informal.”  Our blissful ignorance saved us from the misfortune of Europe’s “shadow banking.”

 Central to the SIVs’ success, as they were developed in the West since two London bankers left Citi in 1988 to start the industry, is the ability of the vehicle, with very little capital, to keep turning around and around quickly, borrowing short and lending long.   All banks, even our own, do a bit of that mismatching.  The deposits they accept, which are really borrowings, and the loans they make to their clients are really funded those  the depositor’s money, for the most part.  But banks do not leverage aggressively, because regulations require them to risk their capital to answer for the gap which leverage could potentially wipe out.

 Since SIVs are not banks and in addition uniformly organized in liberal off-shore jurisdictions (all of Citi’s SIVs were for instance based in the Cayman Islands), they were able to merrily leverage their capital, some borrowing by as much as 14x capital.    In fairness, however, it must be stated that SIV notes were marketed only to the very wealthy and sophisticated.

 For example, Orange County in California had about $80 million in Standard Chartered Bank’s Whistlejacket and $115 million in Citi’s Five Finance.  Serves those descendants of those ungrateful colonists right: after their forebears turned their backs on their mother country more than two hundred years ago, can they now blame Whistlejacket’s managers, who are the descendants of those who remained, for turn their backs, in turn, on them?



Orange Country had a bigger stake in Five Finance of Citi.  But since Citi did not have the same historical baggage, it dealt with its SIV problem differently.

 To market SIVs to sophisticated investors, many SIVs, in addition to coming up with special blends of  highly rated assets, go by names that titillate the wealthy that subliminally suggest: Standard Chartered’s Whistlejacket was touted as a winner like the famous race horse; HSBC’s Asscher Finance and Cullinan Finance evoke the universe of diamonds.

 The names of Citi’s SIVs were markedly of a different kind and, in keeping with the American Bank’s strong retail orientation, were not in the same class as the British Bank’s SIVs.  Can any billioner get excited by the “Five” of  “Five Finance”? Or, unless you geek, by the “Beta” of “Five Finance”? Most likely Beta was chosen because Alpha was already the used in “Alpha Finance” first  SIV set up by Citi in 1988.

 Some feeble attempts, though, of suggesting that its SIVs were of the rich and famous are evident in Citi’s  “Dorada Finance” which brings to mind the color of gold - soft, warm and sparklingly bright – said to be characteristic of Costa Dorada, along the shores of the southern part of Catalonia, Spain; in  “Zela Finance” which refers to a town in Pontus, in what is now Turkey. It was in Zela  where Julius Cesar in a battle in 47 BCE defeated Phamaces II and then sent home what is probably the shortest praise release on record, “Veni, Vedi, Vici”.

 The best that Citi could do was evoke the sense of  the skies  in “Centauri Corporation” which bring to mind the stars of the bright constellation of Centaurus in the southern hemisphere; in “Sedna Finance” that is named after Sedna, a transneptunian object (one that orbits the sun at a greater distance on average than Neptune) and, was, when discovered, named after Sedna, the Inuit goddess of the sea, who was believed to live in the cold depths of the Arctic Ocean.  Citi’s creative juices seemed to have dried up when it involked “Vetra” in “Vetra Finance” meaning, in the ancient languages, storm or wind.

 But, if as Juliet asks Romeo, What's in a name?, many SIVs, to enhance attractability of the wealthy,  were managed or “sponsored” by big name banks.  Sponsorship by a bank, or a reputable financial institution, was single most effective marketing ploy ever employed by the SIVs.  The SIV galazy was a expansive as $400 billion during the haydays of credit: Citi had about a quarter of the pie; HSBC about a fifth; and Standard Chartered Bank had the smallest of the three.

 Good times, however, in tandem to a way of making even the mediocre managers look like a financial genius,  also have a tendency to tempt managers to forget the basics.  Gradually, less than prime assets began creeping into the SIV’s blend.  Never in great numbers; but cumulatively big enough to begin to put at risk not only the thin capital of the SIVs but also receivables of holders of the lower tier notes, i.e. those who had, in exchange of higher yields, gambled on less secure positions in the order of being taken out by the SIV.

 When the times that tried men’s souls rolled in, the credit spigot that used to yield torrents went into mere trickles, and Standard Chartered Bank, HSBC and Citi, like many, were, at least in public, initially in a state of denial.  But when the crisis did not go away the next morning, bank sponsors, all vigorously assured their investors of support.  In the meantime, those SIVs that could started selling their jewels to fund maturing notes of investors.  SIVs quickly shrunk both in value and in the eyes of the Moody’s, Standard and Poors, Fitch, and other rating agencies.  Soon, putting the assets that remained, in order to be palatable, was the only option left for the SIVs that wanted to save both face and life.

 The bank sponsors tried to calm down fears by stating that they were “considering” the grant of a “liquidity” facility for their SIVs.  When that did not work too well, efforts were exerted, by the private sector, to create a “Super SIV” that would bail out the troubled ones.  But since the “exposure” of the different banks varied in major ways, in absolute amounts and as a percentage of their asset base, the banks were not able to come to an agreement quickly amongst themselves.  They all gave many genteel reasons, as could be expected from bankers, but the unsaid (though not for long) suspicion is that it was a bail out effectively designed to save Citi which had the biggest exposure.

 HSBC was the first bank to leave the conference table.  As we described last week, in effect it bit the SIV bullet and relied on the strength of its balance sheet to absorb the impact of taking in the assets of Asscher Finance and Cullinan Finance amounting to about $45 billion.  The rationale: “By dong it this way, HSBC had got control of everything rather than putting it into the Super SIV [which was expected] to take some time to be properly structured and set up”, observes Gordon Scott of Fitch Ratings.

 Citi was Hamlet-like, taking time on stage to ruminate “To be or not to be”.  But one month after the HSBC announcement, Citi said it too would take its SIV assets into its balance sheet.  And did.

 Standard Chartered Bank, as reported two columns ago, abandoned its own son, Whistlejacket.  A London-based credit analyst at Calyon in London said: ``It seems Standard Chartered is the only bank sponsor not willing to stand behind its SIV, in the way that HSBC or Citigroup have done…There is a reputational risk there.''

 Darn the reputational risk.  The Filipino depositors in Standard Chartered Bank were benefited from its decision not to bury the dying Whistlejacket in its balance sheet.  That kept uncontaminated the bank’s ability to make good its London’s home office guarantee of all its Philippine branches.  Cheers to Standard Chartered.