How did Enron use SPE’s to hide large amounts of debt?

Question by amcenicola: How did Enron use SPE’s to hide large amounts of debt?

Best answer:

Answer by werner.herzog
A special purpose entity is a company that is created by a parent company, usually to carry out a specific, limited purpose, such as the securitization of a set of assets. An SPE may be set up as a corporation, partnership, LLC, or trust. Enron created lots and lots of SPEs. As long as Enron technically controlled no more than 50% of an SPE, Enron was not required by accounting rules to consolidate the SPE’s assets and liabilities, so any debts belonged to the SPE and did not show up on Enron’s books. The simplest way Enron hid debt in the SPEs was by selling assets to the SPEs, which had borrowed money in order to purchase the assets. The problem was that Enron was liable to repay the loans taken out by the SPEs. So, basically, Enron was making a sale to itself, showing a profit on its books, and hiding the corresponding loss in the SPE. These false profits (sorry) covered up Enron’s actual business losses.

What do you think? Answer below!

SPE’s for securitization?

Question by Johnny Question: SPE’s for securitization?
How do investors look at SPEs for the purpose of securitization of receivables? Should they be skeptical?

Best answer:

Answer by JoeyV
I’ll assume that you are in the US as I have no idea how this works in some other random country. I also assume that you mean the investor in the originating company, not an investor in a security based on the receivables.

In the US, the sale of receivables to the SPE must be a “true sale” pursuant to FASB 125. The rules on this are pretty strict and, unless there is reason to suspect the company is pretty dirty, I would generally regard it that way. This is significantly better than some off-balance sheet transfer that represents securitized lending and is some way of hiding debt.

I know this sort-of smells like Enron’s SPV’s or something, but I believe that most securitized receivables are just replacing traditional financing of receivables by a cheaper alternative and one that cleans up the balance sheet. Would you prefer that a company borrow short-term money by floating commercial paper, for instance, or securitizing their receivables? In the former instance, they have debt on the books that is probably higher on the capital pecking order than your investment and in the latter they have cash. Since the SPE is “bankruptcy-remote”, the securities issued by the SPE are likely to be more highly rated than the commercial paper so the cost to the company is probably less.

Skepticism is always good, but I think that you can be skeptically optimistic about this.

Know better? Leave your own answer in the comments!