Special Purpose Vehicles, or SPVs, have been extensively used as a means of securitizing property-based assets. Since the 1980s, large financing corporations have come to rely on SPVs and similar products to spread risk and move liabilities off of their balance sheets. The Great Recession reignited concerns in the financial markets about potential risks after banks had been converting pools of mortgages into securities and selling them to investors in the form of SPVs.
How a Special Purpose Vehicle Works
An SPV sometimes called a Special Purpose Entity or SPE is an orphan company created to disaggregate risks in underlying assets and reallocate them to investors. These vehicles can issue bonds to raise additional capital at more favorable borrowing rates. They also create a benefit by achieving off-balance sheet treatment for tax and financial reporting purposes for a parent company.
The SPV itself acts as an affiliate of a parent corporation, which sells assets off of its own balance sheet to the SPV. The SPV becomes an indirect source of financing for the original corporation by attracting independent equity investors to help purchase the debt obligations. This is most useful for large credit-risk items, such as subprime mortgage loans.
Not all SPVs are structured the same way. In the United States, SPVs are often limited liability corporations or LLCs. Once the LLC purchases the risky assets from its parent company, it normally groups the assets into tranches and sells them to meet the specific credit risk preferences of different types of investors.
Selling a Property Investment to an SPV
To see why property investments are attractive holdings in an SPV, consider the following scenario: a bank grants a loan for a property and assumes the credit risk. The mortgage is an asset of the bank. Rather than hold onto that asset and receive slow interest payments, the bank creates an SPV and sells the mortgage asset to it. As a result, the bank's balance sheet looks less leveraged and it reduces its direct credit risk.