Can someone please clarify how an SPV is able to get any credit rating “it wants”? Also, can someone please clarify how credit enhancement works (which I think is what the SPV uses to get a better credit rating)? Thanks!
Special Purpose Vehicle/ Entity (SPV or SPE) is a subsidiary separate from the parent company with its own asset/ liability structure. It is mainly used to finance a specific project or asset, and since it’s a seperate entity, its obligations are secured even if the parent company goes bankrupt - thus a credit enhancement from the bank’s perspective.
In the past it was used to hide debts (there is an optional reading on Enron in level 1 text i think) for the parent company to move liabilities off the book. But now i think the accounting standards require the parent company to show consolidated financial statements (Accountants here correct me if i’m wrong).
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Hi, thanks for the reply, but it wasn’t really the answer I was looking for… I know what an SPV is but I don’t understand how it can be used for credit enhancement - the book mentions that an SPV can literally get any credit rating it wants - I don’t really understand how that works.
Thanks
Okay, perhaps i should be more specific with my answer.
Like i said, SPV has a seperate asset/ liability structure. Credit enhencement can be achieved for the PARENT by removing debt from its books and limits risk if the project/ transaction fails.
As for the SPV, “it can get any credit rating it wants” because of the flexibility of its capital structure, credit rating improves if the SPV has 1) higher quality assets as collateral, 2) higher asset ratio, or lower D/E.
I think that’s all you need to know for L1, in practice, for instance, SPVs purchase loan contracts from originators and issue debt securities. Most of them are “over-collateralized” in a sense that the cashflow generated provide income above the interest on the securities issued.
Don’t kill yourself over this. Lot more details at L2… you will get to CDOs, CDSs, and other fixed income tranching topics that will facilitate your understanding of the ability to acquire “any credit rating you please as an SPV/SPE.” Just focus on L1 material.
If you got time to kill, use it to cover the fluff in Econ or reread Ethics.
OK, I guess this will be dealt with in more detail at level 2 (although I do understand it a bit better now with regards to capital structure) so I will concentrate more on other material just now. Thanks for your help!