A special purpose entity (SPE), more often called a special purpose vehicle (SPV), is created to carry out a specific business purpose or activity. SPVs are frequently used in structured finance transactions, such as in asset securitizations, joint ventures, or to isolate certain company assets or operations. SPVs can be created through a variety of entities, such as trusts, corporations, limited partnerships, and limited liability corporations.
SPVs are used by many companies for an array of financing purposes. They are, and should continue to be, an integral part of most structured finance transactions. An explanation of how SPVs are used in asset securitizations can clarify some of the issues involved.
How the transaction is structured
Asset securitizations permit a company to sell a pool of assets to an SPV created specifically to acquire them. A percentage equity investment (typically 3-20%) is required from an independent third-party investor representing a legal equity ownership in the SPV. The investment must be "at risk," and the percentage of equity investment is based upon the fair market value of the assets transferred.
The SPV pays for the assets by issuing securities to investors in the capital markets. The securities can bear interest at fixed or variable rates and are typically highly rated investment grade securities that can attract a broad base of investors. The interest and principal due under the securities are paid from the income stream of the assets purchased by the SPV.
Off-balance sheet treatment
Under some circumstances, it may be desirable to remove assets and their corresponding liabilities from the balance sheet of the company, and a sale of the assets to an SPV will accomplish this. However, the sale has to be properly structured to actually transfer both the substantial risks and the rewards of ownership. So, for example, if the sale is coupled with guarantees from the seller concerning performance of the financial assets being transferred, the risks are not really being transferred. In such a case, it could be misleading to shareholders not to disclose the risk retained on the balance sheet.
Similarly, a third-party equity investor must control the SPV's activities and bear the risk of the investment in order for the sale to constitute an arm's length transfer. If the SPV truly assumes the risk and controls the assets transferred, its activities are not controlled by or on behalf of the company that sold the assets to the SPV, then off-balance sheet treatment, rather than consolidation on the balance sheet of the company, usually will be appropriate. The issue, then, is not whether SPVs can be used for asset securitizations, but whether the securitization has been structured and accounted for according to the rules applicable to such structured financial transactions.
Making an SPV "bankruptcy remote"
The SPV usually is created in such a way that it is "bankruptcy remote," which means that the assets sold to the SPV are not at risk if either the SPV or the company whose assets are being securitized become insolvent. Also, if the SPV has no indebtedness other than the asset-secured loans or trade payables, the SPV is unlikely to become insolvent as a result of its own activities.
Experienced professionals make a difference
Asset securitization provides another way for a company to raise cash in the capital markets as well as transfer the risk of default on high-risk debt, such as credit card receivables. If asset securitization could be a desirable way for your company to raise cash, an experienced professional can help you evaluate whether the costs of the transaction outweigh the benefits. Experienced professionals also can properly structure an SPV transaction and advise on how it should be accounted to comply with existing rules.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.