An account receivable is a company asset analogous to a loan to a customer. It represents the company’s capital invested into a product for a particular buyer. Domestic accounts receivable may, thus, be brought into a borrowing base for extending credit to a Bank’s customer. Foreign accounts receivable typically cannot. Export Credit Insurance changes this.
Export Credit Insurance, also known as Foreign Trade Credit Insurance, is a risk management tool that may allow lenders to add over-seas accounts receivable to a customer’s collateral base and, thus, increase the potential size of the credit. Insurance polices are issued by private insurance companies and the Export – Import Bank of the United States. This insurance policy protects businesses selling abroad from losses due to credit risk, such as protracted nonpayment defaults and insolvency or bankruptcy of its foreign buyers. From a lenders’ perspective, therefore, Export Credit Insurance secures foreign receivables by reducing the risk of loss for nonpayment.
Export Credit Insurance creates opportunities for lenders
An account receivable is not a secure asset until it has been paid or collected. Loan officers understand this and will analyze domestic AR portfolios closely and may require receivables insurance that provides security for these assets. If foreign accounts receivable are insured, these assets also change in nature. Insured foreign AR is more secure than uninsured receivables and, thus, may be used as collateral or brought into a borrowing base to further extend a customer’s credit. An insurance policy is, thus, in a sense the loan collateral just as it would be for domestic AR.
Most banks’ lending guidelines require that any foreign AR brought into the borrowing base must be fully insured. Close attention to these and other terms of an Export Credit Insurance Policy is critical. This is where the obstacles to using foreign AR in a borrowing base enter in. First, Export Credit Insurance covers “sales” made during the policy period, meaning that current foreign AR is not covered. Further, fluctuations in foreign AR and the fact that claims paid under a credit insurance policy may decrease the policy amount may cause an insurance short-fall. In those instances, an insurance cushion above what would otherwise be fully insured is advisable.
The wrong Export Credit Insurance coverage presents problems for lenders.
Fully insured foreign AR may be brought into a borrowing base, but full insurance is just a start. Lenders need to closely analyze Export Credit Insurance policies and examine multiple possible scenarios that could cause collateral shortfalls. These include the following:
- Is there sufficient insurance, including a cushion for a growing foreign AR portfolio or to account for losses paid by the insurer? (Policies have “Total Policy Value” limitations that mean, as claims are paid, the value of the policy decreases by an equal amount).
- What are the AR reporting requirements placed on the customer and will the bank receive notice that material foreign AR is more than 60 days past due? (If an insured misses a claim filing or reporting deadline, the insurer may deny the claim).
- What is the process for filing and timeline for paying claims? (Most policies have “Country Specific Waiting Periods” of 60 to 360 days in which the insurer may attempt to collect without having to pay the claim).
- If a claim is paid, are the proceeds assignable to the bank? (The lender may, alternatively, insist that claim proceeds are paid to the Bank directly as a beneficiary of the policy).
From this list of issues, two general concerns for lenders arise: (1) is the policy amount sufficient to cover all foreign AR and account for seasonality of AR, claims paid that may reduce the policy amount, and other costs of collections that may, depending on the terms of the policy, be chargeable against the policy amount; and, (2) does the lender have the right to file a claim or collect proceeds of the policy, either as a named insured or an assignor? Here are a few tips to help lenders navigate these policies.
TIP ONE: Verify a Sufficient Policy Amount
The borrower and its insurer may make prudent risk management decisions without taking into consideration the lender’s borrowing guidelines. That is, a company with $5 million in foreign accounts receivable, but with geographically concentrated and financially sound customers, may not see the need for $5 million in Export Credit Insurance. Indeed, if only a small percentage, for example, $500,000, of the borrower’s foreign AR is beyond 60 days past due, the borrower might consider it a prudent company risk management strategy to purchase $500,000 of insurance. That may be a prudent risk management strategy, but it is insufficient for lending purposes. Banks view foreign AR differently – not as an asset, but rather as an unsecured and uncollectable loan, unless insured.
TIP TWO: Verify Limits on Credit Extended to Foreign Customers
To illustrate, suppose a manufacturing company has $10 million in accounts receivable, with $5 million being foreign AR. The foreign AR may only be brought into the borrowing base if fully insured. But, an analysis of foreign AR reflects a growing export business and concentration among a few key foreign customers. In this situation, foreign AR could exceed the amount initially thought to be safely insured, or one of the borrower’s buyers may place an unforeseen large order necessitating the customer to exceed prior credit limits. Insurance may be increased as well, but this can be expensive.
Consider another illustration. A company with $5 million of foreign AR is fully insured, but is subject to a $250,000 foreign AR write-off as a result of the insolvency of a foreign buyer. When the insurer pays the claim for $250,000, it will reduce the policy amount (i.e. the limit the insurer will pay on future claims) from $5 million to $4.75 million. The moment the $250,000 claim is paid, therefore, the amount of insurance on the foreign AR portfolio decreases by an equal amount. When foreign AR returns to $5 million, the portfolio is underinsured from the bank’s perspective by $250,000. There must be customer specific credit limits in place, and an equal amount of insurance, to guard against this shortfall.
TIP THREE: Know the Waiting Periods
A country specific waiting period is the additional number of days from the original date a foreign receivable was due that a receivable must remain past due before a loss under the policy has occurred. The waiting period for Canadian receivables is usually zero (there is little or no political risk there so receivables may be treated as domestic); but waiting periods range from 90 days in Germany, Italy and Japan, to 360 days in countries such as Nicaragua, Afghanistan and Serbia. During the waiting period, insurers may attempt to collect the debt or negotiate terms with the foreign buyer. If collected, the receivable would be paid, less a collection fee of, for example, 15%.
TIP FOUR: Obtain a Loss Payment Endorsement
Insurance companies pay claims to insureds (i.e., the Bank’s customers). But, if the Bank’s customer is insolvent, in default or otherwise deemed by the Bank to be insecure, the Bank will want to step into its customer’s place to collect foreign accounts receivable or Export Credit insurance proceeds directly. To do this, the policy must contain a Loss Payment Endorsement. The Bank and its customers may also be asked to execute a “Bank Beneficiary” form.
A Loss Payment Endorsement or Bank Beneficiary form allows the Bank to file a claim under the policy. If a claim is paid or a receivable is collected, the insurer will pay the Bank directly, unless the Bank releases the proceeds to its customer. In other words, the Bank has the same rights under the policy as its customer.
Contact a professional to review the Export Credit Policy.
Most bank customers will have a relationship with an insurance broker with access to this type of insurance. The broker will be working for the customer with the incentive to get coverage in place at the best price the customer is willing to pay. Insurance brokers however are not typically well versed in lending guidelines and they do not represent the lender. A careful review of the collateral base and analysis of Export Credit insurance, if any, should be done as part of any lender due diligence.