D.2 Creating an understanding of SPVs Flashcards
1
Q
How SPVs contributed to the 2007 subprime mortgage crisis
A
- large amounts of subprime mortgages leading up to 2007
- mid-2007: real estate values begin falling = SPVs suffer heavy losses and affect solvency of many large institutions
2
Q
features and uses of SPVs
A
- securitization of loans
- sponsors can pool many loans together and sell tranches to investors as bonds - Asset transfer
- SPVs can contain assets that would be otherwise difficult to transfer - Financing a parent company without directly investing in the parent company
- Risk sharing and relocation
- sponsor can relocate risk to an SPV
- SPVs are bankrupt remote
- SPV has no legal connection to the sponsor - financial engineering
- abuse of SPVs can manipulate capital ratios and regulatory requirements, hide losses - Raising Capital
- SPVs can raise capital at a more favorable borrowing rate
- Credit quality of SPV is based on the SPV assets, not the sponsor credit quality
3
Q
SPV structure
A
- The sponsor creates an SPV
- the sponsor sells assets to the SPV, assets are now owned by the SPV
- SPV issues bonds to investors to finance the purchase of the assets
- the assets now reside in the SPV and are no longer on the sponsor balance sheet
- an investment bank operates between the sponsor and the SPV
- credit quality is based on the SPV assets, not the sponsor credit quality
4
Q
Key SPV benefits to sponsoring firms
A
- Asset ownership - allows for ease of transfer between parties
- easy and cheap to establish
- easy to limit activities and prohibit transactions
- sponsor can incorporate an SPV in the most attractive jurisdiction from a regulatory perspective
- Tax benefits - SPV assets are exempt from certain direct taxes
- Legal protection - sponsor has limited legal liability for failed SPVs
- isolation of financial risks - SPV is bankrupt remote
- SPVs can help sponsor meet regulatory requirements easier by transferring certain assets off the balance sheet
5
Q
key SPV risks to sponsoring firms
A
- lack of transparency - makes this difficult to manage risk
- can have multiple layers of securitized assets - reputational risk for the sponsor if the SPV fails
- poorly performing SPVs will reflect negatively on the sponsor
- poorly performing SPVs will damage sponsor relationship with investors
- poorly performing SPVs will affect the sponsors ability to raise more capital
- if the sponsor holds a large equity tranche in the SPV the firm may be taking on more risk than if the SPV asset were kept on the balance sheet
- forced sale of assets from an affiliated SPV can depress value of related assets on the sponsor balance sheet
- lax regulatory standards for SPV could cause the sponsor to create more risk in the SPV than if the assets had remained on the balance sheet
6
Q
key SPV-related failures
A
- Towers Financial
- enron
- Bear Sterns
- Lehman Brothers
all used to hide debt, losses, and liabilities
7
Q
Recent regulatory changes (SPVs)
A
- No longer automatic that an SPV asset can be held off balance sheet.
- IFRS requires SPVs to be held on balance sheet if the sponsor effectively controls the SPV - regulatory changes for SPVs
- tightening of covenants in lending documentation
- firmer legal risk management practices
- increased emphasis on counterparty risks - Basel III
- require banks to hold more capital
- supervisory review process for risk managment
- enhanced risk disclosure
8
Q
Managing the risks of SPVs
A
- more governance based on the SPV complexity
- reporting capability to assess and report SPV exposure
- monitor quality of transferred exposures
- regular oversight of SPV activity
- market participants should be able to assess and risk manage factors that increase transaction capability
- tighten reporting requirements
- external regulators should not be allowed to provide consulting to the same clients they provide ratings for
- simpler structures
- standardize documentation and disclosures
- Consolidate with sponsor for supervisory/risk management purposes if the sponsor provides financial support for SPV