Special Purpose Vehicle (Special Purpose Entity)

Definition

The term special purpose vehicle refers to a legal entity created to fulfill a specific objective. Special purpose vehicles are oftentimes limited liability corporations or limited partnerships.

Explanation

Also known as special purpose entities, a special purpose vehicle (SPV) is a legal entity that is able to fulfill its obligations to investors even if the originating company files for bankruptcy. Oftentimes a SPV is leveraged to lower a company's overall risk profile since they are frequently used to remove assets off the originator's balance sheet. This type of arrangement can help lower risk and provide greater flexibility. For example, a financial institution can create a SPV to move a portfolio of loans off its balance sheet. By doing so, it will lower its overall risk and maintain or raise its credit rating.

A company may also create a SPV when financing a large capital project. This allows the company to enter into relatively large projects without placing the entire company at risk of default. SPVs play a critical role in the process of securitization, which allows credit originators (lenders) to remove some of the risk in their portfolio and move it to another party. The company first identifies income producing assets they wish to remove from their balance sheet and move over to the SPV. Interest bearing securities, funded by the cash generating assets, are then issued by the SPV to investors.

Related Terms

securitizationsenior loanequity interest, commercial paper