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HSBC Holdings (HBC)
Is More Trouble on the Horizon for HSBC as it Bails out 2 Funds?
HSBC, the largest bank in the United Kingdom, announced today that it is taking a different route than its American counterparts to protect its two structured investment vehicles (SIVs) which together have about $45 billion of exposure to the mortgage and asset-backed securities market. Instead of attempting to bolster these off-balance sheet investments by joining the $80 billion super-fund that some US banks (e.g. Citigroup (C: Charts, News, Offers), Bank of America (BAC: Charts, News, Offers)) are attempting to float in order to create demand for the underlying mortgage-based assets, HSBC is moving its two SIVs, directly onto its own balance sheet which, in essence, means that it is agreeing to fund the debt obligations of the two funds to ensure that they stay afloat. Why did HSBC go down this route and what other issues related to the current credit crunch is the company dealing with?
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SIVs are essentially investment vehicles designed to take advantage of the spread between lower short-term interest rates and higher long-term rates by borrowing money with short-term maturities, primarily in the form of commercial paper and using the funds to purchase long-term bonds. The bonds that SIVs purchase are typically backed by mortgages, credit card payments, auto loans etc. Usually, banks such as HSBC and Citigroup create the SIVs and provide them with support but they function off the balance sheet as independent entities and attract their own investors. That is until they run into trouble and that is precisely what has happened over the last few weeks. SIVs have become a victim of the credit crunch into two different ways. The lack of credit and financing in the open market has had a massive detrimental impact on the short-term commercial paper market (i.e. the major source of funds for SIVs) and the value of the assets that SIVs own have been declining precipitously because of the problems in subprime mortgage market. Therefore, not only has a major source of money been taken away from these SIVs, compromising their ability to function and make investments, they can't sell their assets to raise the much needed financing either because nobody is looking to buy what they are selling (i.e. mortgage backed bonds). The only way to sell these bonds right now is at a substantial discount and that of course involves taking a major financial hit.
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Citigroup is rumored to be the biggest player in the SIV field and has sought to provide pricing support for the mortgage based assets of SIVs by working with the Treasury Department and other US banks to create a superfund which will purchase these assets and inject liquidity into the market for them. HSBC has shied away from joining this fund and now it looks like it will definitely stay away from it. The London based bank is instead going to take its troubled SIVs and put them on its balance sheet. The two SIVs, Cullinan Finance and Asscher Finance, will go on HSBC's balance sheet, ballooning it by $45 billion, which means that HSBC will directly provide funding for them. The bank is expected to provide about $35 billion in financing for the two vehicles over the next 7-8 months. By doing this, HSBC ensures that the two funds will not have to worry about rolling over (i.e. extending) their existing debt obligations as the current creditors will be paid off by HSBC as and when the loans mature. This will give the SIVs flexibility to continue with their current operations and perhaps, most importantly, will ensure that they are not forced to offload their mortgage heavy bond portfolio onto a depressed market (i.e. no firesale).
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That really is the biggest fear here. Banks such as HSBC don't want their SIVs to be forced into a position by creditors where they will have to sell their assets to meet financing requirements because these assets which are already notoriously hard to value are currently only selling for cents to a dollar (sometimes even as low as 20 cents to a dollar). So HSBC is making the bet that over the medium to long term, the market will rebound and the portfolios held by the SIVs will regain their lost value as the subprime mortgage mess and the credit crisis becomes a thing of the past. In the meantime, HSBC is stepping up to provide the financing to ensure that the SIVs live to fight another day. But the risk lies in the fact that these mortgage heavy portfolios never regain all of their lost value. If that were to happen, then HSBC will never see an appreciable return on the financing that it is providing to these funds. To be sure, the losses will first be taken by the equity investors in these funds (a fact that HSBC took great pains to point out in its statement today) but if the losses are substantial enough then the equity investors will not be able to cover them by themselves and creditors (which is essentially what HSBC is becoming to these funds) will have to take the hit too.
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So while HSBC did admirably bite the bullet this morning, there is a chance it will have to field further damage from the SIVs in the future. Add in the fact that Goldman Sachs (GS: Charts, News, Offers) estimates that HSBC may have to write down an additional $12 billion due to defaults in home mortgage loans and it's clear that the credit crisis is having a major impact across the pond too.
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