Commercial credit insurance is playing more of a key role in EMEA ABCP transactions, said Moody's Investors Service in a recently published report. According to its Credit Insurance Agreement in EMEA ABCP Transactions, around 40% of the new trade receivables deals funded by EMEA conduits in 2004 and 2005 utilize credit insurance, up from 25% in 2003. Moreover, Moody's said it expects this trend to continue as the use of insurance can help originators achieve off-balance sheet treatment under revised IAS39, which states that the seller must transfer substantially all risk of the receivables.
However, complications arise because the form of issuance policy typically provided by an issuer to its corporate clients is not well suited for an ABCP conduit, said Edward Manchester, who authored the report. "Certain modifications are needed to ensure - to a Prime-1 standard - that the conduit will have full and timely access to the required amount of credit enhancement."
The report describes the factors Moody's considers when reviewing credit insurance agreements. The rating agency's analysis of an insurance agreement covers both a review of its terms and an assessment of how these fit together with the other components of the transaction, including the liquidity facility, eligibility criteria and termination events.
According to the report, credit insurance is provided to the purchaser and is sized to cover all or some of the defaulted receivables in excess of the first loss protection - the sum of the overcollateralization and other such credit enhancement. For partially supported transactions, the sum of the credit insurance coverage and first loss protection is at least equal to the total required amount of transaction-specific credit enhancement determined to a Prime 1 standard.
In reviewing these agreements, Moody's looks at the structure of the agreement, which is key in understanding the inherent risks. Sometimes the insurance agreement states that coverage is provided for receivables that are sold and assigned to the purchaser. This definition of insured receivables may expose ABCP investors to "true sale risk," which is the risk of having no legal assignment of receivables to the purchaser, Moody's said.
The rating agency also examines what constitutes an insured event. The report said that the list of insured events must cover every circumstance where receivables are treated as defaulted for the purpose of the liquidity facility. Even so, it is common for insurance agreements to exclude coverage for insured events that are caused by certain circumstances, Moody's said.
Moreover, insurers generally set limits on the amount of coverage provided when it comes to individual obligors and receivables originated in certain countries. There is also the aspect of maximum liability, which refers to the overall limit on the amount of claims that can be made under the policy. Since the impact of the insurance limits on the total amount of enhancement cannot easily be assessed, the agreement should include an eligibility criterion.
In some instances, the insurance agreement might provide that claims can only be made for defaulted receivables that are over an uninsured first loss amount. "As a corollary to this, there should be a provision in the receivables purchase agreement to the effect that no receivables can be purchased unless, following the purchase, the available first loss protection will be at least equal to the uninsured first-loss amount (together with the amount required to cover any uninsured percentage)," said the rating agency.
Timing risks are also a major concern. In most cases, the insurer is only obliged to make payments following a short grace period after the purchaser has made a valid claim. This means there could be a time when receivables have become defaulted receivables, possibly leaving Moody's unable to give full credit to the insurance as enhancement for the commercial paper holders. This risk could be mitigated by either obliging the conduit administrator to deliver an insurance claim on any monthly determination date when receivables are reported as default receivables or by including a restriction where commercial paper cannot mature within the insurance grace period following each monthly determination date.
As for payments, the purchaser assumes various payment obligations under the agreement and, additionally, the insurer may be entitled, under certain extreme circumstances, to the return of insurance payments it has made. However, Moody's said obligations give rise to certain ratings considerations for purchasers, including bankruptcy remoteness and time subordination risk.
Defenses to insurance payments are also always a concern. Unless Moody's is comfortable that no breach or misrepresentation will occur, the insurer must waive all defenses to payment. Additionally, most insurance agreements last one year and renewal is often automatic, with either party being able to give note of non-renewal. "The insurance agreement may provide for the policy to terminate following certain events, including notice of termination by the insurer," Moody's concluded "These provisions are acceptable so long as all receivables that are purchased prior to any non-renewal or termination remain insured."
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