SPV separate, exactly, purpose, special, rating

water2012

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!

mnieman

hmm...still hazy, probably need to read the page on it over and over again.
Thanks for the effort though!

Benjiko

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!

homie

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.