SPEs as Off-Balance Sheet Vehicles.ppt

Paul Zarowin SPEs as Off-Balance Sheet Vehicles Key Issues Special purpose entities (SPE) Synthetic leases Enron case Special Purpose Entity (SPE) Subsidiary, partnership, etc. set up for specific, finite period, activity. Often highly leveraged (high ratio of debt/equity or debt/assets). Also for ongoing investments, subs, joint ventures. Consolidation of Subs, SPEs To avoid consolidation of SPE subsidiary, investment, or joint venture, parent must have: 50% or less of sub’s common O/E, or for SPE’s outside residual claim must bear substantial risk; de facto implementation has required 3% of total assets. Example: A = L + E SPE 100 94 6 P=parent 97 94 (upto 97) 3 (or less) Outside owner 3 0 3 key point: keep debt off of the Balance Sheet Synthetic Leases A synthetic lease is created when an SPE buys an asset on behalf of the company (or sometimes from the company itself) and leases this asset (back) to the company. Synthetic Leases (cont’d) The company records the synthetic lease as an operating lease; if it had leased the asset directly and not through a SPE it would have recorded it as a capital lease. The operating lease treatment is preferred by companies because it allows them to keep the lease obligation off-balance-sheet. There are also tax motives to use a synthetic lease (if you are interested see RCJ page 598). SPEs as Off-Balance Sheet Debt Vehicles The SPE vehicle that was initially used in the context of synthetic leases started to be more pervasively and creatively applied during the 1990s. Companies use SPEs as a back door to remove debt, obligations and other liabilities off the balance sheet. Enron case is an example for that. Enron case Enron was one of high-flyer stocks in wall street throughout the 1990s. At the end of 2001 it was revealed that for years Enron hid billions of dollars in off-balance sheet entities and used these entities to camouflage losses and artificially inflate its income. Within weeks of the