Structured Finance

Fundamentals Of Asset Financing

When an SPV transaction involves asset financing, it usually falls into one of two categories:

• Acquisition. In an aircraft financing, for example, the SPV would acquire the aircraft from the manufacturer. In order to purchase the airplane, the SPV uses the proceeds of a non-recourse loan (backed by the plane). If the SPV structure involves a trust, the trust beneficiary may provide equity capital as well. Following the purchase, the airplane is leased to an operator, under an operating lease and the lease income is used to service the debt.
• Securitization. Companies that originate loans such as mortgages or credit card balances may often convert these debt obligations to marketable securities, which are sold to investors. An SPV typically purchases the assets (the loan contracts) from the originator and in turn issues debt securities to raise funds to cover the purchase price. Through the trust structure, the trustee holds the shares of the SPV for the benefit of the owners of the debt securities. A true sale opinion will state that the originator has in fact relinquished ownership of the assets.

For both types of transaction, cash flow generated by the underlying asset enables the SPV to make the required principal and interest payments. Most SPV transactions are over-collateralized, so that the assets involved are projected to produce more income than necessary to pay interest on the securities that have been issued.

When the transaction winds up, the SPV will sell its assets to redeem the outstanding securities, re-paying investors and lenders. Swaps or other hedging agreements may be used to reduce the risk of fluctuating interest-rates and currency exchange rates.

Asset-financing transactions are often associated with tax, legal, and financial issues. A Special Purpose Vehicle (SPV) can provide the ideal solution. An SPV is an entity created to engage in a specific transaction, most commonly for asset acquisition, leasing and securitization. Structures which may be used, include corporations, trusts, partnerships, stichtings and limited liability companies.

Special Cases

SPV transactions may also be designed to meet specific objectives for example:

• Asset repackaging. An asset that may have some undesirable characteristics can be transferred into the SPV. The SPV in turn will issue notes and/or certificates to investors, probably under Rule 144A of the Federal Securities Act, as an institutional private placement.
• Conduits. Many different asset classes may be appropriate for inclusion in a conduit. For example, lenders may use a form known as a structured investment vehicle (SIV).

Banks and other financial institutions often hold loans that are considered to be high-quality, based on the collateral and/or the borrower's credit-worthiness. Ownership of such loans may be unappealing because regulatory requirements cause the firms holding these assets to back them with a high proportion of capital. In order to avoid this obligation, yet still profit from the high-quality loans they have made, a bank can establish a SIV, which will purchase the high-quality assets. This removes those assets from the bank's books and reduces the bank's need to maintain additional regulatory capital.

Subsequently, the SIV can sell securities to investors, backed by the high-quality assets it is holding. For various reasons, including excess collateralization, shorter maturities and repayment guarantees, the interest payable on the securities issued by the SIV may be lower than the interest paid by the ultimate borrowers. Thus the originator of the loans can make money from arbitrage of the interest-rate spread between its interest income and its cost of funds.

Collateralized Loan Obligations (CLOs). In these transactions, the lender does not sell the assets to an SPV. Instead, the lender creates derivatives in the form of credit-linked notes or credit default swaps. The notes or swap agreements are sold to the SPV, which issues securities that are backed by the income from these derivatives. In this manner, a CLO may serve to securitize the income and the risk of the underlying loans but not the actual assets. This structure allows the sponsor to retain some degree of control over the original assets.

Collateralized Debt Obligations (CDOs). These arrangements provide the sponsor with access to the assets and their income, in certain circumstances. Often, CDOs are used to repackage asset-backed securities, mortgage-backed securities, and other structured products.

Conclusion

Many entities can benefit from using an SPV, but not every financial firm provides the support that sponsors need.

Circumference provides companies interested in establishing an SPV with extensive experience in domicile management and ensures that all documentary requirements are met, all fees are paid on time, and provides guidance related to the chosen jurisdiction’s regulations and benefits.

Circumference offers a comprehensive package of accounting and administrative services necessary to maintain the SPV's independence from the ultimate sponsor. It is this status as a stand-alone entity that enables an SPV to provide maximum benefits. The need for expertise may be especially acute when it comes to off-balance sheet financing in general, and SPVs in particular. With continuing focus on corporate accounting reform, more scrutiny may be given certain transactions and more disclosure might be required. In this environment, Circumference brings well established expertise to the table.