Securitization
Securitization is a structured finance process that distributes risk by aggregating debt instruments in a pool, then issues new securities backed by the pool. The form of financial instruments used to obtain funds from the investors is securities.
Securitization often utilizes a special purpose vehicle (SPV), alternatively known as a special purpose entity (SPE) or special purpose company (SPC), reducing the risk of bankruptcy and thereby obtaining lower interest rates from potential lenders.
An SPV is a legal entity created by a firm (known as the sponsor or originator) by transferring assets to the SPV, to carry out some specific purpose or circumscribed activity, or a series of such transactions. SPVs have no purpose other than the transactions for which they were created.
Some of the reasons for creating special purpose entities are:
- Securitization: SPEs are commonly used to securitize loans (or other receivables). A bank may wish to issue a mortgage-backed security whose payments come from a pool of loans. However, to ensure that the holders of the mortgage-back securities have the first priority right to receive payments on the loans, these loans need to be legally separated from the other obligations of the bank. This is done by creating an SPE, and then transferring the loans from the bank to the SPE.
- Risk sharing: Corporations may use SPEs to legally isolate a high risk project/asset from the parent company and to allow other investors to take a share of the risk.
- Finance: Multi-tiered SPEs allow multiple tiers of investment and debt.
- Asset transfer: Many permits required to operate certain assets (such as power plants) are either non-transferable or difficult to transfer. By having an SPE own the asset and all the permits, the SPE can be sold as a self-contained package, rather than attempting to assign over numerous permits.
- Financial engineering: SPEs are often used in financial engineering schemes which have, as their main goal, the avoidance of tax.
- Property investing: Some countries have different tax rates for capital gains and gains from property sales. For tax reasons, letting each property be owned by a separate company can be a good thing. These companies can then be sold and bought instead of the actual properties, effectively converting property sale gains into capital gains for tax purposes.
Allied Asset provides securitization services including establishment of SPV`s in connection with structured finance transaction as well as SPV administration and credit enhancement.