I need a little help understanding how special purpose vehicles work. Specifically, how exactly can they separate the assets from a corporation, how do they improve the credit rating? Thanks!
Company A sets up SPV-B that will be the owner/operater of a power plant. The plant is funded with debt, but has a lower interest rate because the debt is collateralized by the plant and it’s revenues, ie. rent/lease paid by company A. There are not 100 other operations that back the debt, or have seniority. It’s similar to the difference between Muni general obligation (GO) bonds and revenue bonds. In the end though, if their are contracts, control, ownership that makes Company A financially tied to the SPV-B, the risk of SPV-B debt is still tied to Company A, even though some look at it as a seperate entity. Hope this helps with the general idea.
hmm…still hazy, probably need to read the page on it over and over again. Thanks for the effort though!
SPVs are a lot simpler than you may think. All it means is that a parent company creates a subsidiary company (the SPV) for the purpose of financing or using derivatives. For example, if a company wants to finance a project, it may do so by issuing debt. This company can issue debt directly to market participants, or it could create an SPV. Let’s look at why a company may use SPV: 1) Let’s say the company has a low credit rating. If it issued debt, the debt would also get low credit rating. Also, the financing cost would be high for low-credit debt. In this case, the company may want to create a special purpose vehicle, which means a subsidiary “company” that is legally separate from the parent company. Then, the SPV could be polished to have high-credit and then debt would be issued, thereby reducing its financing cost. (Of course, the reduced financing cost should be weighed by the cost of credit enhancement to determine if this is the most profitable route) 2) Perhaps the company wants to take part in some risky financial assets or derivatives. Investing in these assets could give them a high return, if lucky, but it could also fail them with negative returns. If they do not want to risk their whole company to go belly up as a result of a failed asset or project, it would be wise for this company to create an SPV then have the SPV to invest in the risky assets or derivatives. That way, because the SPV is legally separate from the parent company, the risk is wholly taken on by the SPV. Hope that helps!
Elaborating on what rockstar said… By an SPV being a seperate legal entity, it is protected from the possibility of the Parent company filing chapter 11. This will enhance the credit of the SPV. If a parent wants to issue ABSs, this is a good way to do so. However, Enron is a good example of how using SPVs went wrong. Read up.
This turns up in L-2 as well. Here’s my take An SPV is generally formed to securitise the receivables of a company. It’s a diff entity from the company and is bankruptcy remote.SPVs are formed to reduce cost of debt. Because of it’s nature, it can be kept apart from the balance sheet. But accounting rules now prohibit the non- consolidation of SPVs. Based on certain conditions, it has to be consolidated. For ex- If the Receivable securitisation is with recourse( ie the company forming the SPV takes the risk of defaults), then the SPV should be consolidated. There are other conditions too( from L-2), but I think this should give you a basic idea.
thanks for all the feedback! I also found this article, really good elaborate explanation…so for those interested… http://www.som.yale.edu/faculty/gbg24/SPVs%20and%20Securitization.pdf