A special purpose vehicle (SPV) is a legal entity created by a parent company to isolate financial risk. Companies typically use SPVs to finance large projects and transfers assets in order to isolate those assets from the parent company in case of bankruptcy or other financial issues. SPVs are commonly used when companies securitize assets or seek structured financing arrangements like issuing bonds.
SPVs allow companies to protect certain assets while still obtaining financing. They also provide benefits like tailored risk allocation and flexible structuring to meet the needs of various stakeholders. Overall, SPVs serve an important role in helping companies raise asset backed facilities while separating the risk from the parent.
SPV Creation Process
Creating an SPV follows a general standardized process:
Debt Facility Closing
The parent company works on a debt facility with a warehouse provider. As a part of debt facility docs, a SPV will be contemplated. This is done closer to signing the debt facility docs.
Incorporate SPV
Attorneys then incorporate the SPV as an independent legal entity. The SPV is incorporated as identified in the debt facility documents.
Transfer Assets
As the assets are originated, the originator sells the assets to the SPV. The warehouse provider lends against the assets in the SPV. The transfer is done through a true sale process. This isolates the risks of those assets from the parent.
Operate SPV
The parent company operates the SPV as a fully owned subsidiary. In most cases, the SPV has no physical operations. Instead, the parent company simply manages the assets on behalf of the SPV through servicing agreements.
Distribute Funds
As the assets produce income through client payments, interest, or other means, the SPV passes those funds onto investors as coupon or principal payments. The distribution schedule is set in advance as defined in the debt facility documents.
Dissolve SPV
Once the securitized assets pay out and the securities mature, the SPV has completed its purpose. The company then dissolves the SPV entity.
SPV Benefits
SPVs provide three main advantages for parent companies:
Isolate Financial Risk:
Primarily, SPVs isolate certain assets from other company holdings. If the parent company enters bankruptcy or faces major liabilities, the isolated assets within the SPV remain beyond reach of creditors. This allows the parent to raise money against those assets despite poor financial health.
Tailor Risk Profiles
Through careful structuring, the parent company can slice risks into tranches using credit enhancements within an SPV. This appeals to a wide range of investors with different risk appetites.
Obtain Lower Financing Rates
By removing assets from the parent’s balance sheet, the SPV can secure lower-cost financing backed by healthy collateral assets. This provides cheaper growth capital for the parent company.
SPVs also benefit investors by providing transparent securitization arrangements tied to defined assets. Overall, SPVs serve a facilitative role in financing large projects and asset transfers.
Typical SPV Structures
SPVs utilize several common structural arrangements tailored to particular assets and financing goals:
Collateralized Loan Obligations (CLOs)
A CLO issues various debt tranches collateralized by the cash flows from an underlying portfolio of loans. The SPV holds the loans and distributes payments from them to CLO investors according to a defined priority schedule.
Mortgage-Backed Securities
In this structure, the SPV holds title to a pool of mortgages underwritten to homeowners. Investors receive principal and interest payments as the mortgage borrowers make payments to the SPV. MBS investors take on mortgage prepayment and default risk.
Asset-Backed Commercial Paper
A company transfers assets to an SPV, which then uses those assets as collateral to continuously issue short-term commercial paper. Investors receive fixed or floating interest rate payments until the paper matures in 1-270 days.
Synthetic CLOs
This simulates exposure to a pool of leveraged loans through credit default swaps instead of a direct asset transfer. The SPV purchases CDS protection from banks and sells corresponding default protection to investors. Investors take on risk of CDS losses.
Credit Derivatives Product Companies
SPVs hold credit derivative products instead of cash-based assets. For instance, they may hold credit default swaps or collateralized debt obligations (CDOs) tied to corporate bonds or loans. The SPV structures corresponding derivatives to sell investors.
SPV Costs and Setup Considerations
Creating and operating an SPV incurs both direct and indirect costs:
Incorporation Expenses
Forming an SPV legal entity requires attorneys fees for drafting contracts, liaising with regulators, et cetera. Incorporation costs range from $15,000 to $40,000.
Ongoing Administration
The lender contracts and agent to manage filings, track payments, provide accounting services and other administrative functions. These typically cost $25,000 to $75,000 annually. The range depends on the size of the facility. Manging a smaller facilities cost a lot less.
Credit Enhancements
If going for securitizations, obtaining credit ratings, guarantees, insurance policies or letters of credit to improve the SPV’s credit profile also generate fees upfront and over time. Enhancement costs vary widely based on options selected.
Servicing Fees
If the parent company needs to subcontract management of assets within the SPV, it incurs additional servicing fees paid to the asset manager or servicer. For example, 0.10% to 0.75% of balances annually.
The extensive use of SPVs across debt financing markets underscores their tremendous utility. SPVs create specialized investment opportunities by converting risks tied to underlying assets. At their foundation, SPVs simplify complexity – they add value by partitioning complex capital structures into smaller, discrete pieces that appeal to a wider range of investors.