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Four Benefits of Non-Payment Insurance for Project Finance Lenders

Project finance lenders are increasingly turning to non-payment insurance (NPI), also known as structured credit insurance, to facilitate lending deals. NPI covers banks and other financial institutions when borrowers fail to pay back loans, enabling project finance lenders to leverage the bank's credit limit on the borrower and allow the bank to obtain capital relief to lend more money.

Having evolved significantly over the past several years, these policies now offer several benefits, which are increasingly being recognized in the market. As of 2015, project finance NPI now accounts for 10% of the total NPI market in the US, up from 4% in 2013.

Typically, project finance lenders enter into a syndicate with other lenders to provide loans for infrastructure deals. NPI has given lenders the same lending capacity without involving other banks. Rather than having active partners, as is the case with a loan syndicate, the insurance policy merely provides a backstop, enabling lenders to act more independently.

The benefits of NPIs for project finance lenders include:

  1. Risk appetite: NPI enables lenders to take on larger deal tickets and complete deals that would typically exceed the bank’s credit limits. It also enables the lender to manage obligor group, sector, or country risk concentrations.
  2. Competitive advantage:  By not involving other banks, NPI provides a competitive advantage. Clients are not introduced to your competitors. The insurance enables you to lend amounts that maintain relevancy for sponsors and buyers that you may not have acting alone.
  3. Revenue: Larger tickets equal larger upfront fees, meaning lenders with NPI behind them can increase their revenue.
  4. Regulatory: NPI may help optimize the bank's use of regulatory capital, with many jurisdictions allowing the policy to count as tier-one regulatory capital under Basel III rules, providing capital relief for banks.

NPI insurance capacity has increased significantly over the past five years, with the largest project finance loan we’ve seen insured around $500 million. Project finance deals are often measured in billions, making NPI best suited to midsize transactions or facilitating an individual bank’s participation in a larger transaction.

It’s also important to remember that NPI is an insurance contract rather than a straight guarantee. Like any insurance policy, there are conditions such as representations and warranties made by the insured bank and administrative responsibilities that the bank needs to meet to maintain coverage. Failure to comply with these conditions can impair coverage.  However, these operational risks are manageable and entirely within control of the insured lender.

Aside from using NPI, the most common method for banks to manage default risk is to syndicate the loan to other banks, or employ unfunded (or funded) risk participation from other institutions. There are customized credit default derivative instruments for project finance loans, but market and price of these tools make them less attractive to lenders.

As demand for project finance increases, instigated by the need to fund critical infrastructure projects around the world, we expect lenders to use alternative forms of risk transfer, such as NPI, to stay relevant in the project finance lending arena.