The Most Typical Holding in a Special Purpose Vehicle

Special purpose vehicles (SPVs) have been used extensively 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 their balance sheets. The Great Recession reignited concerns in the financial market about potential risks after banks converted pools of mortgages into securities and sold them to investors in the form of SPVs. Read on to find out more about these vehicles, how they work, and what makes property-based investments common in SPVs.

Key Takeaways

  • A special purpose vehicle is an orphan company created to isolate risks and reallocate assets to investors.
  • Property investments are typically held in special property vehicles.
  • Companies can transfer property ownership to an SPV and sell off that entity, paying (lower) capital gains tax instead of property sales tax.
  • Banks can sell mortgage assets to SPVs, lowering the leverage on their own balance sheets.

What Is a Special Purpose Vehicle (SPV)?

A special purpose vehicle is an orphan company created to disaggregate and isolate risks in underlying assets and reallocate them to investors. These vehicles, which are also called special purpose entities (SPEs), have their own obligations, assets, and liabilities outside the parent company.

Special purpose vehicles have their own obligations, assets, and liabilities.

SPVs 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.

SPVs are considered to be bankruptcy-remote companies. This means there is little to no impact on the parent company if it goes bankrupt, and vice versa. As such, they are designed to protect both companies from insolvency.

How Special Purpose Vehicles Work

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 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 (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.

There are several reasons why SPVs are created. They provide protection for a parent company's assets and liabilities, as well as protection against bankruptcy and insolvency. These entities can also get an easy way to raise capital. SPVs also have more operational freedom because they aren't burdened with as many regulations as the parent company.

Selling a Property Investment to an SPV

Property investments are most commonly held in special property vehicles. In most cases, a company can create an SPV in order to cut down on the tax implications resulting from a property sale. For example, a company can transfer a piece of property to an SPV if the sales tax is higher than the capital gains tax. If and when the parent company decides to dispose of the asset, it can put the SPV up for sale instead of the property itself. This makes the company responsible for the capital gains tax rather than the property sales tax.

Here's another scenario demonstrating why property investments are attractive holdings in an SPV. A bank grants a loan for a piece of 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 it the mortgage asset. As a result, the bank's balance sheet looks less leveraged and it reduces its direct credit risk.

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  1. Institute for the Study of Labor. "The Great Recession of 2008–2009: Causes, Consequences and Policy Responses," Page 19.

  2. U.S. Securities and Exchange Commission. "Private Funds and the Application of the Custody Rule to Special Purpose Vehicles and Escrows," Pages 1-2.

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