In order to carry out a specific activity or purpose for business, a special purpose vehicle (SPV), often referred to as a special purpose entity (SPE), can be created. These SPVs are often used in structured finance transactions, such as the isolation of certain company operations or assets, joint ventures, or asset securitizations. A variety of entities can be used to create an SPV, including limited liability corporations, limited partnerships, corporations, and trusts.
Many companies use SPVs for a variety of purposes for financing. For most structured financial transactions, they are an integrated part of the process. In order to clarify some of the issues, it is important to understand how these asset securitizations use these SPVs.
The Structure of the Transaction
SPVs are specifically created to acquire a pool of assets after those assets have been secured by a company. Legal equity ownership in the SPV is required from an independent third-party investor who must have a 3-20% equity investment.
The percentage of the equity investment must be based upon the value at fair market prices of the transferred assets, in addition to the requirement that the investment be “at risk”.
Securities are issued to capital markets’ investors in order for the SPV to pay for the asses. These securities may bear interest at variable or fixed rates and attract a broad base of investors because they are typically highly rated investment grade securities. Both the principal and interest that are due under the securities are paid from the asset’s income stream that the SPV management services have purchased.
In some cases, it is best to remove from the balance sheet of the company the assets and their corresponding liabilities. This can be accomplished by a sale of the assets to an SPV. However, in order to transfer both the rewards of ownership and the substantial risks, the sale must be properly structured.
So, consider a case in which the risks are not truly being transferred if the sale is coupled with a seller guarantee about the transferred financial assets’ performance. In this case, not disclosing the balance sheet risks can mislead shareholders.
In a similar case, in order for the sale to be considered an arm’s length transfer, a third party equity investor must bear the risk of the investment and control the activities of the SPV. When the SPV controls the transferred assets and truly assumes the risk, then the company that sold the assets to the SPV has no control of its activities. In this case, it is usually appropriate to use off-balance sheet treatment instead of using consolidation on the company’s balance sheet.
The question then becomes whether or not the securitization has been accounted for and structured according to applicable rules used in such structured financial transactions and not whether the SPVs can be used for asset securitizations.
Setting Up an SPV to Be Bankruptcy Remote
Should the company whose assets are being securitized or the SPV become insolvent, then the assets sold to the SPV are not at risk when the SPV is created in such a way that it is bankruptcy remote. And, there is little likelihood that the activities of the SPV will cause it to become insolvent if it has no indebtedness other than trade payables or the asset-secured loans.
Professionals with Experience Make a Difference
When a company needs to transfer the risk of default on credit card receivables or other high-risk debt or raise cash in the capital markets, asset securitization provides another way to do this. A professional with experience in asset securitization can help you to determine if there will be benefits to your company in terms of raising cash that outweigh the costs of the transaction.