Residual Value Insurance
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Residual Value Insurance
Residual Value Insurance (“RVI”) protects a lender against a market downturn or other economic factors that could adversely affect the insured residual value of the mortgaged property at the scheduled maturity of the loan.
RVI pays the lender an amount equal to the agreed residual value at the loan’s scheduled maturity which is typically equal to the lender’s balloon amount.
RVI provides advantages to commercial real estate owners, developers and institutional lenders by enhancing credit tenant lease (“CTL”) financings.
- The use of RVI in CTL financings allows property owners to realize more financing proceeds by requiring less cash flow over the term of the credit tenant lease to amortize the loan down to the insured residual value amount.
- RVI protects the lender at scheduled maturity by ensuring that it will receive an amount equal to the agreed residual value which is typically equal to the lender’s balloon amount.
- RVI also satisfies certain regulatory requirements affecting U.S.-based insurance company lenders allowing them to receive favorable reporting and risk-based capital treatment for CTL investments that are not fully amortizing.
Investors in CTLs are predominantly U.S.-based insurance companies, a few foreign insurance companies and certain public pension funds. U.S.-based insurer investments are subject to oversight by the National Association of Insurance Commissioners (“NAIC”). Current NAIC CTL guidelines limit the amount of unamortized principal at maturity (not to exceed 5% of the original loan amount). RVI is recognized by the NAIC as an acceptable methodology to permit a larger balloon amount.
If structured properly, CTLs receive favorable reporting treatment (“Schedule D”) resulting in a risk-based capital charge for the lender that is lower than the risk-based capital charge for traditional commercial real estate financings.
How does RVI work? A residual value insurance policy is put in place with the payment of a single premium at the inception of the CTL financing. At the scheduled maturity of a CTL financing, if the owner does not repay the loan in full including the balloon amount due, the RVI policy pays the lender(s) an amount equal to the agreed residual value amount. If the insurance company pays a claim pursuant to the RVI policy, the insurance company succeeds to the lender’s position through an assignment of the loan and the underlying loan documents. The insurance company may elect to foreclose on the property or sell the note to a third party. The owner may still retain ownership of the property by paying the insurance company the amount of the claim payment plus any accrued interest. During the term of the CTL financing, the property must be maintained to avoid deferred maintenance.
CRE Insurance Solutions will also broker RVI coverage for traditional (non-CTL) commercial real estate financings.
The customers for RVI include lenders, real estate owners and developers, investment and mortgage bankers, and professional services entities such as law firms and accounting firms.
RVI is available for most commercial real estate property types including: office, retail, industrial, medical, multi-family and parking garages. Special purpose properties are considered on a case by case basis.
RVI is part of a series of policies designed to help property owners, developers, investors and lenders close critical gaps in insurance protection. Other coverages include: Lease Enhancement Insurance, Shortfall Insurance and Zoning Non-Conformance Insurance.