PRIVILEGED & CONFIDENTIAL ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 601 Lexington Avenue New York, NY 10022
INTERNAL MEMORANDUM
FROM: Carlos Espinoza, Associate
TO: Douglas Carmichael, Partner; Yuki Nakamura, Associate
CC: Sylvia Hartwell, Partner (Tax); Francesca Morano, Partner
DATE: August 1, 2022
RE: Risk Retention Compliance Analysis — Quorum Receivables Funding 2022-1 LLC, $500,000,000 Insurance Premium Finance Asset-Backed Securities
MATTER NO.: 1025-00007
CLIENT: Quorum Insurance Holdings Corp. ("QIH")
This memorandum is protected by the attorney-client privilege and constitutes attorney work product. It is intended solely for the use of the addressees and persons identified on the distribution list. Any dissemination, distribution, or copying of this memorandum or its contents without the prior written consent of Calderwood & Harkness LLP is strictly prohibited.
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I. Executive Summary
The purpose of this memorandum is to analyze the credit risk retention requirements applicable to the proposed $500,000,000 asset-backed securitization of insurance premium finance receivables by Quorum Receivables Funding 2022-1 LLC ("QRF 2022-1" or the "Issuer"). This memorandum is prepared at the request of our client, Quorum Insurance Holdings Corp. ("QIH"), in connection with QIH's proposed inaugural term securitization of insurance premium finance receivables originated by its wholly owned subsidiary, Quorum Premium Finance LLC ("QPF").
The governing statute is Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. 111-203), which added Section 15G to the Securities Exchange Act of 1934, codified at 15 U.S.C. § 78o-11. Section 15G directed the Securities and Exchange Commission (the "SEC"), the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the Federal Deposit Insurance Corporation (the "FDIC"), the Office of the Comptroller of the Currency (the "OCC"), the Federal Housing Finance Agency (the "FHFA"), and the Department of Housing and Urban Development ("HUD") to jointly prescribe regulations requiring any "securitizer" of asset-backed securities to retain not less than five percent (5%) of the credit risk of the assets collateralizing the securities. The implementing regulations (the "Risk Retention Rules") were adopted in final form in October 2014 and are codified, among other places, at 17 C.F.R. Part 246 (SEC) and corresponding parts for the other promulgating agencies (12 C.F.R. Part 244 (Federal Reserve), 12 C.F.R. Part 373 (FDIC), 12 C.F.R. Part 43 (OCC)). For purposes of this memorandum, citations are to the SEC regulations at 17 C.F.R. Part 246, which serve as the primary reference given the offering format.
Conclusion. Based on our analysis, QIH, as the "sponsor" of the securitization within the meaning of the Risk Retention Rules, is required to retain at least five percent (5%) of the fair value of the ABS interests issued by QRF 2022-1. No exemption from the risk retention requirements is available for asset-backed securities collateralized by insurance premium finance receivables. QIH proposes to satisfy this obligation through a "horizontal risk retention" structure — specifically, by retaining the $15,000,000 overcollateralization / retained interest piece (the "Eligible Horizontal Residual Interest" or "EHRI"), which represents 3.0% of the total issuance par amount of $500,000,000 but is expected to represent at least 5% of the fair value of all ABS interests when valued using the prescribed fair value methodology under GAAP (ASC 820). This memorandum analyzes the legal sufficiency of this proposed approach, examines the available alternatives, identifies the specific compliance steps required, and flags open issues for discussion and resolution prior to the expected closing of the transaction.
The balance of this memorandum is organized as follows: Section II provides background on the transaction structure; Section III describes the applicable legal framework; Section IV analyzes the available risk retention options; Section V sets forth the fair value calculation and the 5% test; Section VI addresses the applicability of potential exemptions; Section VII details the compliance structure and documentation requirements; Section VIII discusses the interaction between risk retention and other structural features of the transaction; Section IX addresses rating agency considerations; Section X identifies risk factors and open issues; Section XI sets forth our recommendations and next steps; and Section XII provides our conclusion.
II. Background — Transaction Structure
A. Parties and Roles
The following parties are involved in the proposed securitization transaction. Their respective roles are summarized below and described in greater detail in the relevant transaction documents.
Sponsor. Quorum Insurance Holdings Corp. ("QIH") is a Delaware corporation publicly traded on the New York Stock Exchange under the ticker symbol "QIHC." QIH is headquartered at 400 Atlantic Street, Suite 2200, Stamford, Connecticut 06901. As of its most recent public filing (Form 10-K for the fiscal year ended December 31, 2021), QIH reported total assets of approximately $4.8 billion and total stockholders' equity of approximately $1.2 billion. QIH's senior management includes Marcus Devereaux, Chief Executive Officer; Priya Raghavan, Chief Financial Officer; Nolan Whitford, General Counsel; and Sandra Ling-Hwang, Treasurer. QIH serves as the "sponsor" of the securitization for purposes of the Risk Retention Rules, as discussed in greater detail in Section III.C below.
Originator / Seller / Servicer. Quorum Premium Finance LLC ("QPF") is a Delaware limited liability company and a wholly owned subsidiary of QIH. QPF is the originator of the insurance premium finance receivables that form the collateral pool for the securitization. QPF originates insurance premium finance loans to commercial policyholders across all fifty (50) states through a network of independent insurance agents and brokers. As of the cut-off date of June 30, 2022, QPF's total receivables portfolio (including receivables not included in this securitization) was approximately $2.1 billion. QPF will serve as the initial servicer of the receivables pursuant to the Servicing Agreement and will sell the receivables to the depositor (QRH) pursuant to the Receivables Sale Agreement.
Depositor (Intermediate SPV). Quorum Receivables Holding LLC ("QRH") is a Delaware limited liability company that is 100% owned by QPF. QRH serves as the intermediate special purpose vehicle (the "depositor") in the two-step transfer chain from QPF to the issuer. QRH is structured as a bankruptcy-remote entity and has an independent manager, Eleanor M. Vasquez of Fortbridge Corporate Services LLC, whose consent is required for any voluntary bankruptcy filing or similar action. QRH has no employees, no material assets other than the receivables transferred to it by QPF and the related transfer documentation, and no liabilities other than those arising under the transaction documents.
Issuer. Quorum Receivables Funding 2022-1 LLC ("QRF 2022-1") is a Delaware limited liability company formed for the sole purpose of issuing the notes and acquiring the receivables from QRH. QRF 2022-1 is a bankruptcy-remote special purpose entity whose sole member is QRH. QRF 2022-1 has an independent manager, Timothy R. Callan of Fortbridge Corporate Services LLC, whose consent is required for any voluntary bankruptcy filing or similar action. QRF 2022-1 will issue the Class A Notes, Class B Notes, and Class C Notes pursuant to the Indenture and will grant a security interest in the receivables and related assets to the indenture trustee for the benefit of the noteholders.
Structuring Agent / Lead Bookrunner / Placement Agent. Ridgeline Capital Markets LLC ("Ridgeline") is acting as the structuring agent, lead bookrunner, and placement agent for the offering. The key Ridgeline personnel on this transaction include Julian Weatherstone, Head of ABS Origination, and Rebecca Tran, Managing Director. Ridgeline's internal deal identifier for this transaction is RCM-IPF-2022-0041. Ridgeline is represented by Calloway & Brandt LLP (Harrison Collier and Megan O'Shaughnessy).
Indenture Trustee / Paying Agent. Calvoneth Trust Company, N.A. will serve as indenture trustee and paying agent under the Indenture. Calvoneth Trust Company, N.A. is a national banking association organized under the laws of the United States with its corporate trust office located in Philadelphia, Pennsylvania.
B. Capital Structure
The proposed capital structure of the securitization is summarized in the following table:
The rated notes (Class A, Class B, and Class C) have been assigned preliminary ratings by two nationally recognized rating agencies: Brindoval Ratings Inc. ("Brindoval") and Pinnacle Rating Services LLC ("Pinnacle"). The offering is structured as a Rule 144A / Regulation S private placement, and the notes will not be registered under the Securities Act of 1933, as amended.
The notes will pay interest monthly based on the Secured Overnight Financing Rate ("SOFR") plus the applicable spread. Principal payments will follow a sequential payment structure, with Class A Notes receiving principal payments before Class B Notes, and Class B Notes receiving principal payments before Class C Notes. The overcollateralization / retained interest piece sits at the bottom of the capital structure and represents the most subordinated economic interest in QRF 2022-1.
C. Asset Pool
The initial pool of receivables backing the securitization has the following characteristics as of the cut-off date of June 30, 2022:
The underlying assets are short-term insurance premium finance receivables. Each receivable represents a loan made by QPF to a commercial policyholder to finance the payment of insurance premiums. The receivables are secured by the borrower's assignment to QPF of the unearned premium refund rights under the financed insurance policy. In the event of a borrower default, QPF (as servicer) has the right to cancel the underlying insurance policy and collect the unearned premium refund from the insurance carrier, which typically provides a substantial recovery on the defaulted receivable.
The receivables pool is granular and well-diversified, with no single obligor representing more than 0.75% of the initial pool balance and no single state representing more than 20% of the initial pool balance. The largest insurance carrier exposure in the pool does not exceed 15% of the initial pool balance. These concentration limits will be maintained as eligibility criteria during the revolving period.
D. Transfer Chain
The receivables are transferred from the originator to the issuer through a two-step transfer chain designed to achieve a "true sale" of the receivables for bankruptcy-remoteness purposes:
Step 1: QPF → QRH (Receivables Sale Agreement). QPF, as originator and seller, sells and assigns the receivables to QRH, as depositor, pursuant to the Receivables Sale Agreement. This transfer is intended to constitute a "true sale" of the receivables under applicable law, with the result that the receivables would not be part of QPF's bankruptcy estate in the event of a QPF bankruptcy. The Receivables Sale Agreement includes representations and warranties by QPF as to the eligibility and quality of the receivables, as well as repurchase obligations for receivables that breach such representations and warranties.
Step 2: QRH → QRF 2022-1 (Receivables Transfer Agreement). QRH, as transferor, transfers and assigns the receivables to QRF 2022-1, as issuer and transferee, pursuant to the Receivables Transfer Agreement. This transfer is also intended to constitute a "true sale" of the receivables, with a back-up grant of a security interest from QRH to QRF 2022-1 in the event that the transfer is recharacterized as a secured loan rather than a true sale.
Step 3: Grant of Security Interest / Indenture. QRF 2022-1 grants a security interest in the receivables and all related assets (including collections, accounts, and proceeds) to Calvoneth Trust Company, N.A., as indenture trustee, for the benefit of the holders of the Class A Notes, Class B Notes, and Class C Notes, pursuant to the Indenture.
The two-step transfer chain — with the interposition of the depositor (QRH) between the originator (QPF) and the issuer (QRF 2022-1) — is a standard securitization structure that provides additional bankruptcy-remoteness protection and is consistent with the structure contemplated by the Risk Retention Rules for purposes of identifying the "sponsor" and "depositor" in the securitization chain.
E. Transaction Periods
The transaction contemplates the following key periods:
Revolving Period. The revolving period will extend for twenty-four (24) months from the closing date. During the revolving period, collections on the receivables (other than excess spread and amounts required for interest and fee payments) will be used to purchase additional eligible receivables from QPF (through QRH), subject to the eligibility criteria, concentration limits, and other conditions specified in the Receivables Transfer Agreement. The revolving period is subject to early termination upon the occurrence of certain early amortization events (discussed in Section VIII.B below).
Amortization Period. Following the end of the revolving period (whether at the scheduled end or upon early termination), the transaction will enter a twelve (12)-month amortization period during which collections will be applied to pay down the outstanding principal balance of the notes in sequential order (Class A, then Class B, then Class C).
Legal Final Maturity. The legal final maturity date of the notes is forty-two (42) months from the closing date, which provides a six (6)-month tail beyond the expected end of the amortization period to account for any delays in the receipt of collections.
III. Applicable Legal Framework
A. Dodd-Frank Section 941 — Statutory Overview
Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub. L. 111-203, enacted July 21, 2010) added Section 15G to the Securities Exchange Act of 1934 (15 U.S.C. § 78o-11). The stated purpose of Section 941 was to address one of the perceived root causes of the 2007–2008 financial crisis: the misalignment of incentives between securitizers, who originated and packaged loans for securitization, and investors, who purchased the resulting asset-backed securities. Congress determined that securitizers who bore no ongoing economic exposure to the credit performance of the securitized assets had insufficient incentive to ensure the quality of the underwriting of those assets. Section 941 was designed to correct this misalignment by requiring securitizers to retain "skin in the game" — that is, a meaningful economic interest in the credit risk of the securitized assets.
Specifically, Section 15G(b) of the Exchange Act provides that the federal agencies shall jointly prescribe regulations to require any "securitizer" to retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party. Section 15G(c)(1)(B)(i) establishes the minimum retention level at not less than five percent (5%) of the credit risk for any securitized asset.
Section 15G also contemplates certain exemptions from the retention requirement, including an exemption for "qualified residential mortgages" (Section 15G(e)) and authority for the agencies to exempt or establish a lower retention requirement for certain asset classes if the agencies determine that such exemption or reduced requirement would be appropriate in the public interest and for the protection of investors. The statute also authorizes the agencies to specify the permissible forms, amounts, and duration of the required risk retention. The QRM exemption is not applicable to this transaction because the underlying assets are insurance premium finance receivables, not residential mortgages.
B. Implementing Regulations
The federal agencies adopted final rules implementing Section 941 on October 22, 2014, with publication in the Federal Register at 79 Fed. Reg. 77,602 (December 24, 2014). The final rules became effective on December 24, 2015, for securitizations of residential mortgage-backed securities, and on December 24, 2016, for securitizations of all other asset classes (the "all other ABS" effective date). Because the proposed QRF 2022-1 securitization involves insurance premium finance receivables (which are not residential mortgages), the applicable effective date has long since passed, and the Risk Retention Rules are fully applicable to this transaction.
The implementing regulations are codified by each promulgating agency in its own chapter of the Code of Federal Regulations:
• SEC: 17 C.F.R. Part 246
• Federal Reserve: 12 C.F.R. Part 244
• FDIC: 12 C.F.R. Part 373
• OCC: 12 C.F.R. Part 43
• FHFA: 12 C.F.R. Part 1234
• HUD: 24 C.F.R. Part 267
Although the regulations are substantively identical across agencies, the applicable regulation for a particular transaction depends on the identity of the sponsor and the nature of the securitized assets. Because this transaction involves a non-bank sponsor (QIH is a publicly traded holding company, not a banking entity) and is being offered in the securities markets under Rule 144A and Regulation S, we cite the SEC regulations at 17 C.F.R. Part 246 as the primary reference throughout this memorandum. The substantive requirements are identical regardless of which agency's regulation is cited.
The key provisions of the Risk Retention Rules that are relevant to this transaction include the following, each of which is analyzed in greater detail in the sections that follow:
• § 246.2: Definitions (including "sponsor," "ABS interest," "eligible horizontal residual interest")
• § 246.4: Standard risk retention (vertical, horizontal, and L-shaped options)
• § 246.5: Revolving pool securitizations (seller's interest option)
• § 246.12: Hedging, transfer, and financing prohibitions
• § 246.13–246.20: Exemptions
C. Definition of "Sponsor"
Under the Risk Retention Rules, the "sponsor" is defined as "a person who organizes and initiates a securitization transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity." 17 C.F.R. § 246.2. The sponsor is the entity on which the risk retention obligation is imposed.
In this transaction, QIH is the sponsor. QIH organized and initiated the securitization by causing its wholly owned subsidiary, QPF, to originate the insurance premium finance receivables and to sell those receivables, through the depositor (QRH), to the issuing entity (QRF 2022-1). QIH, as the parent entity, directed the formation of the special purpose vehicles (QRH and QRF 2022-1), engaged Ridgeline Capital Markets as placement agent, retained Calderwood & Harkness LLP as transaction counsel, and controls the overall structure and timing of the securitization. QIH is the entity with the overarching economic interest in the securitization program and the entity that organized and initiated the transaction within the meaning of the Risk Retention Rules.
We note that QPF itself could also be considered a co-sponsor or the direct sponsor, as QPF is the entity that directly sells or transfers the receivables to the depositor (QRH). However, the implementing rules and the preamble to the final rule make clear that the sponsor designation is flexible and can encompass the parent entity that organized and initiated the securitization, even if the parent does not itself directly originate or sell the assets. Because QIH is the entity with the economic interest and the parent that directed the formation of the securitization vehicles, it has been designated as the sponsor for risk retention purposes. This designation is consistent with market practice in comparable ABS transactions where the operating subsidiary originates the assets but the parent holding company serves as the designated sponsor.
D. Definition of "Securitizer"
The statute (15 U.S.C. § 78o-11(a)(3)) defines "securitizer" to mean either "(A) an issuer of an asset-backed security; or (B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer." The implementing regulations focus on the "sponsor" as the entity with the primary retention obligation, effectively operationalizing the statutory term "securitizer" through the more specific regulatory definition of "sponsor."
Accordingly, QIH is both the "securitizer" under the statute and the "sponsor" under the implementing regulations, and QIH bears the primary obligation to retain the required credit risk in connection with the QRF 2022-1 securitization.
IV. Risk Retention Options — Analysis of Alternatives
A. Overview of Permissible Forms
The Risk Retention Rules provide several alternative methods by which a sponsor may satisfy the five percent (5%) retention requirement. The following is a summary of the principal options available under the rules:
1. Standard Risk Retention — Vertical (17 C.F.R. § 246.4(a)). Under the vertical risk retention option, the sponsor retains not less than five percent (5%) of each class of ABS interests issued in the securitization transaction. The retained interests must be of the same class and have the same terms as the ABS interests sold to investors, except that the retained interests are subject to transfer restrictions during the applicable holding period. This approach ensures that the sponsor has a pro rata economic exposure to the performance of each tranche in the capital structure.
2. Horizontal Risk Retention — Eligible Horizontal Residual Interest (17 C.F.R. § 246.4(b)). Under the horizontal risk retention option, the sponsor retains an "eligible horizontal residual interest" (EHRI) in the issuing entity with a fair value (determined in accordance with GAAP) equal to at least five percent (5%) of the fair value of all ABS interests issued. The EHRI must be the most subordinated interest in the issuing entity and must absorb losses before any other ABS interest. This approach concentrates the sponsor's risk exposure in the first-loss position, providing strong incentive alignment because the sponsor bears the initial economic impact of any deterioration in the credit quality of the underlying assets.
3. L-Shaped (Combined Vertical/Horizontal) (17 C.F.R. § 246.4(c)). Under the L-shaped or combined option, the sponsor retains any combination of vertical and horizontal interests, provided that the aggregate fair value of the retained interests equals at least five percent (5%) of the fair value of all ABS interests issued. This approach provides flexibility in situations where the sponsor wishes to retain some vertical exposure (pro rata across tranches) in addition to a horizontal first-loss position, but neither component alone satisfies the full 5% requirement.
4. Seller's Interest — Revolving Pool Securitizations (17 C.F.R. § 246.5). For revolving pool (master trust) securitizations, the sponsor may satisfy the retention requirement by retaining a "seller's interest" equal to not less than five percent (5%) of the unpaid principal balance of all outstanding investor ABS interests issued by the issuing entity. The seller's interest is a first-loss or pari passu interest in the receivables pool that fluctuates as the pool balance changes. This option is specifically designed for master-trust structures, such as credit card securitizations, where the sponsor maintains an ongoing, fluctuating interest in the revolving pool.
5. Representative Sample (17 C.F.R. § 246.8). Under the representative sample option, the sponsor retains ownership of a representative sample of the securitized assets (rather than retaining ABS interests), with an unpaid principal balance equal to at least five percent (5%) of the unpaid principal balance of all securitized assets in the pool. The retained sample must be selected using a methodology that ensures the sample is representative of the full pool in terms of material characteristics. This option is rarely used in practice due to the operational complexity of maintaining a separate pool of retained assets.
6. Originator Risk Retention (17 C.F.R. § 246.11). Under certain conditions, an originator (other than the sponsor) that originated a portion of the securitized assets may satisfy a portion of the sponsor's retention obligation by retaining an interest in the originator's securitized assets. This option is generally available only where multiple originators contribute assets to a single securitization and the sponsor wishes to allocate a portion of the retention obligation to one or more of those originators.
7. Certain Exemptions (17 C.F.R. §§ 246.13–246.20). The Risk Retention Rules provide exemptions from the retention requirement for certain categories of assets and transactions, including qualified residential mortgages, qualifying commercial loans, qualifying commercial real estate loans, qualifying automobile loans, certain government-guaranteed or government-insured assets, certain resecuritizations, and certain foreign-related transactions. These exemptions are discussed in Section VI below.
B. Evaluation for This Transaction
Vertical Option. Under the vertical risk retention option, QIH would be required to retain five percent (5%) of each class of ABS interests issued by QRF 2022-1. Applied to the proposed capital structure, this would result in the following retention requirements:
The vertical option has not been selected for this transaction for several reasons. First, retaining five percent of each class of rated notes would reduce the total amount of notes available for sale to investors by $24,250,000 (across the three rated tranches), which would reduce the transaction proceeds available to QIH and QPF. Second, the vertical option introduces operational complexity, as the retained portions of each class would be subject to transfer restrictions during the holding period, requiring separate tracking and custody arrangements for three separate classes of retained notes. Third, from a marketing perspective, Ridgeline has indicated that the vertical retention approach is less common in the insurance premium finance ABS market and could raise questions from investors accustomed to the horizontal retention approach used in comparable transactions.
Horizontal Option (Selected Approach)
QIH proposes to satisfy the risk retention requirement through horizontal risk retention by retaining the $15,000,000 overcollateralization / unrated retained interest piece as an Eligible Horizontal Residual Interest (EHRI). This is the most subordinated interest in the capital structure of QRF 2022-1 and occupies the first-loss position in the sequential payment waterfall. The EHRI absorbs losses before any rated tranche of notes.
Although the par amount of the EHRI ($15,000,000) represents only 3.0% of the total issuance par ($500,000,000), the Risk Retention Rules measure the retention requirement on a fair value basis, not a par basis. As discussed in Section V below, the fair value of the EHRI — driven by the significant excess spread in the receivables pool — is expected to exceed five percent (5%) of the fair value of all ABS interests. The horizontal retention approach is the most common form of risk retention in the ABS market for non-mortgage asset classes and is well understood by investors, rating agencies, and regulators.
The horizontal option is therefore the recommended and selected approach for this transaction.
Seller's Interest Option
We have also considered whether the seller's interest option under 17 C.F.R. § 246.5 would be available and appropriate for this transaction. QRF 2022-1 features a twenty-four (24)-month revolving period during which collections on the receivables are reinvested in new eligible receivables, which is a characteristic of revolving pool securitizations for which the seller's interest option was designed. However, the seller's interest option was primarily developed for traditional master-trust structures — such as credit card securitizations — in which the sponsor maintains an ongoing, fluctuating undivided interest in a master pool that supports multiple series of investor notes over time.
The QRF 2022-1 transaction, by contrast, is a single-issuance revolving structure with a defined revolving period, a subsequent amortization period, and a legal final maturity. The issuing entity (QRF 2022-1) issues a single series of notes, and the transaction is expected to amortize and terminate within forty-two (42) months. While the revolving feature introduces some characteristics of a master-trust structure, the overall design is more consistent with a discrete, term securitization.
Our analysis concludes that the horizontal risk retention option under § 246.4 is more appropriate for this transaction and provides greater structural clarity and certainty of compliance. However, we note that the seller's interest option could theoretically be available during the revolving period, and we recommend discussing with Ridgeline whether dual compliance — i.e., relying on the seller's interest option during the revolving period and transitioning to horizontal retention during the amortization period — would provide any additional benefits or flexibility. For purposes of this memorandum, the horizontal option under § 246.4 is the primary compliance path, and the analysis that follows is based on that approach.
L-Shaped Option. The L-shaped (combined vertical/horizontal) option under § 246.4(c) has also been considered. Under this approach, QIH would retain a combination of a horizontal interest (the EHRI) and vertical interests (a pro rata portion of each rated tranche), with the aggregate fair value of the retained interests equaling at least five percent (5%) of the fair value of all ABS interests. This approach is not necessary for this transaction because the horizontal retention alone — through the retention of the EHRI — is expected to satisfy the 5% fair value test, as demonstrated in Section V below. If, however, market conditions change and the fair value of the EHRI declines to a level that does not satisfy the 5% test, QIH could supplement the horizontal retention with a vertical component to achieve compliance through the L-shaped approach. We flag this as a potential fallback strategy in Section X below.
V. Fair Value Calculation — 5% Test
A. Methodology
Under the Risk Retention Rules, the fair value of the EHRI must equal at least five percent (5%) of the fair value of all ABS interests issued by the issuing entity. 17 C.F.R. § 246.4(b)(2). The key terms of this calculation are as follows:
Fair Value. The Risk Retention Rules require that fair value be determined in accordance with U.S. generally accepted accounting principles (GAAP), specifically ASC 820 — Fair Value Measurement. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. For ABS interests that are not actively traded (such as the EHRI, which is an unrated, illiquid residual interest), fair value is typically determined using a discounted cash flow methodology that projects the expected cash flows to the holder of the interest and discounts those cash flows at an appropriate market rate.
ABS Interests. The term "ABS interests" is defined broadly in the Risk Retention Rules to include all classes of securities and other financial interests issued by the issuing entity, including rated and unrated notes, certificates, residual interests, overcollateralization amounts, and any other form of interest that represents a claim on the cash flows of the issuing entity. For purposes of this transaction, the ABS interests include the Class A Notes ($375,000,000), the Class B Notes ($75,000,000), the Class C Notes ($35,000,000), and the overcollateralization / retained interest (EHRI) ($15,000,000), for a total par amount of $500,000,000.
Measurement Date. The 5% fair value test is applied at the closing of the securitization transaction and is not subject to ongoing recalculation. The sponsor must determine the fair value of the EHRI and the fair value of all ABS interests as of the closing date (or as close to the closing date as practicable) and must maintain documentation of the fair value determination in its records. Although the test is not subject to ongoing recalculation, the sponsor must maintain the required retention (i.e., the EHRI) throughout the applicable holding period, as discussed in Section VII.B below.
B. Preliminary Fair Value Analysis
We have prepared a preliminary fair value analysis based on the proposed capital structure, the characteristics of the receivables pool, and current market conditions. This analysis is intended to provide an indicative assessment of whether the 5% test is likely to be satisfied; a formal, independent fair value determination will be required at or prior to closing.
Total Par Value of All ABS Interests. The total par value of all ABS interests issued by QRF 2022-1 is $500,000,000, consisting of the Class A Notes ($375,000,000), Class B Notes ($75,000,000), Class C Notes ($35,000,000), and OC/retained interest ($15,000,000).
Fair Value of Rated Notes. The Class A, Class B, and Class C Notes are expected to be priced at or near par at issuance. At the current coupon guidance levels (SOFR + 125 bps for Class A, SOFR + 210 bps for Class B, and SOFR + 375 bps for Class C), and assuming that the final pricing is at or near these guidance levels, the fair value of the rated notes at issuance would be approximately equal to their par amounts. For purposes of this preliminary analysis, we assume that the aggregate fair value of the rated notes is approximately $485,000,000 (i.e., approximately par).
Fair Value of the EHRI (OC/Retained Interest). The EHRI represents the residual cash flows of QRF 2022-1 — that is, the cash flows remaining after payment of all trustee fees and expenses, servicing fees, note interest, and note principal. The fair value of the EHRI depends primarily on three factors: (i) the excess spread generated by the receivables pool, (ii) the projected losses on the pool, and (iii) the discount rate applied to the projected residual cash flows.
Excess Spread Analysis. The excess spread is the difference between the yield on the receivables pool and the all-in cost of the securitization (including note coupon, servicing fee, and other transaction expenses). The key inputs to the excess spread analysis are as follows:
• Weighted average APR of the receivables pool: 7.85%
• Weighted average coupon on rated notes (estimated blended rate at coupon guidance, weighted by par amount): approximately SOFR + 162 bps blended, which, at then-current SOFR levels (approximately 2.33% as of the date of this memorandum), translates to an all-in blended note rate of approximately 4.0% to 4.5%
• Servicing fee: 1.00% per annum (paid to QPF as servicer)
• Trustee and other fees: de minimis relative to pool balance (estimated at approximately 0.02% per annum)
• Net excess spread (before losses): approximately 2.35% to 2.85% per annum on the pool balance
Applied to the initial pool balance of $612,000,000, the annual net excess spread (before losses) is approximately $14.4 million to $17.4 million. After deducting the historical average net loss rate of 0.42% per annum (approximately $2.6 million per annum on the initial pool balance), the annual net excess spread after losses is approximately $11.8 million to $14.8 million. Over the life of the transaction (up to 42 months), the cumulative residual cash flows available to the EHRI are substantial, even under conservative assumptions.
Implications for Fair Value. The EHRI has a par amount of $15,000,000, but its fair value reflects the present value of all expected residual cash flows over the life of the transaction, not merely the par amount. Because the receivables pool generates significant excess spread (approximately 2.35%–2.85% per annum before losses), the total residual cash flows available to the EHRI holder over the life of the transaction are expected to materially exceed the $15,000,000 par amount.
Illustrative Calculation. The 5% test requires that the fair value of the EHRI equal at least 5% of the fair value of all ABS interests. For purposes of illustration:
• Assume total fair value of all ABS interests ≈ $500,000,000 (rated notes at approximately par + EHRI at fair value). Note that the total fair value could exceed $500,000,000 if the EHRI fair value exceeds its $15,000,000 par amount, which would in turn raise the 5% threshold slightly. The calculation is iterative, but for practical purposes, the threshold is approximately $25,000,000.
• 5% threshold ≈ $25,000,000
• Based on preliminary cash flow modeling conducted by QIH's treasury group and reviewed by this firm, the fair value of the EHRI (based on projected residual cash flows discounted at a rate consistent with market yields for comparable residual interests) is estimated in the range of $28,000,000 to $35,000,000.
• The estimated fair value of the EHRI exceeds the 5% threshold of approximately $25,000,000, with a margin of approximately $3,000,000 to $10,000,000.
Conclusion. Based on this preliminary analysis, the $15,000,000 par amount of the OC/retained interest piece, when valued at fair value in accordance with GAAP ASC 820, is expected to satisfy the 5% test. The significant excess spread in the receivables pool — driven by the wide differential between the weighted average APR of the receivables (7.85%) and the all-in cost of the securitization (approximately 5.0%–5.5% including servicing fee) — provides a substantial cushion above the 5% threshold.
C. Recommendation — Valuation
We recommend the following steps to ensure that the fair value determination is properly documented and defensible:
Independent Valuation. QIH should engage Meridian Ledger LLP (Robert Falcone, engagement partner) or another qualified independent valuation firm to prepare a formal fair value determination of the EHRI at or prior to closing. The valuation should be conducted in accordance with GAAP ASC 820 and should document the methodology used (expected to be a discounted cash flow analysis), the key assumptions (including projected excess spread, loss rates, prepayment speeds, and discount rate), and the resulting fair value conclusion. Meridian Ledger LLP has been engaged by QIH for audit and advisory services in prior periods and is familiar with QPF's receivables portfolio, which should facilitate an efficient engagement.
Disclosure in Offering Memorandum. The fair value determination methodology and the resulting fair value of the EHRI should be disclosed in the Offering Memorandum in the dedicated risk retention disclosure section. The disclosure should include, at a minimum, the identity of the valuation firm, the methodology employed, and the fair value conclusion (or a range, if the final determination is not available at the time the preliminary Offering Memorandum is circulated).
Record Retention. QIH should maintain the fair value determination and all supporting documentation in its records in accordance with the Risk Retention Rules and applicable record retention policies. The records should be maintained for the duration of the holding period and for a reasonable period thereafter (we recommend at least five years after the termination of the holding period).
Market Condition Monitoring. We note that the fair value of the EHRI is sensitive to changes in market conditions, including changes in SOFR rates, ABS credit spreads, and the credit performance of the receivables pool. If market conditions deteriorate materially between the date of this memorandum and the pricing date — for example, if credit spreads widen significantly, reducing the excess spread in the transaction — the fair value of the EHRI could decrease, potentially jeopardizing the 5% test. We recommend that QIH and Ridgeline monitor market conditions closely and that QIH be prepared to update the fair value analysis at or near pricing. If the fair value of the EHRI falls below the 5% threshold, QIH should consider augmenting the horizontal retention (e.g., by increasing the OC amount) or adopting an L-shaped approach that supplements the horizontal retention with a vertical component.
VI. Exemptions — Applicability Analysis
We have reviewed the exemptions available under the Risk Retention Rules to determine whether any exemption from the five percent (5%) retention requirement is applicable to this transaction. For the reasons set forth below, we conclude that no exemption is available.
A. Qualified Residential Mortgage (QRM) Exemption — § 246.13
The Risk Retention Rules provide an exemption from the retention requirement for securitizations of "qualified residential mortgages" (QRMs), defined to align with the definition of "qualified mortgage" (QM) under the Consumer Financial Protection Bureau's Ability-to-Repay rule (12 C.F.R. Part 1026). This exemption is not applicable to the QRF 2022-1 transaction because the underlying assets are insurance premium finance receivables, not residential mortgages.
B. Qualifying Commercial Loan, Commercial Real Estate, or Auto Loan Exemptions — §§ 246.14–246.17
The Risk Retention Rules also provide exemptions (or reduced retention requirements) for securitizations of certain categories of assets that meet specified underwriting criteria:
• Qualifying Commercial Loans (§ 246.15): Applies to commercial and industrial loans meeting specific criteria related to leverage, debt service coverage, and other underwriting metrics. Insurance premium finance receivables are not commercial loans within the meaning of this exemption.
• Qualifying Commercial Real Estate Loans (§ 246.16): Applies to commercial real estate loans meeting specific criteria. Not applicable to insurance premium finance receivables.
• Qualifying Automobile Loans (§ 246.17): Applies to automobile loans meeting specific criteria related to loan-to-value ratios, borrower creditworthiness, and other underwriting metrics. Not applicable to insurance premium finance receivables.
None of these asset-class-specific exemptions applies to insurance premium finance receivables.
C. Exemption for Certain Resecuritizations — § 246.18
The Risk Retention Rules provide a limited exemption for certain resecuritizations (i.e., securitizations in which the underlying assets are themselves ABS interests). This exemption is not applicable because the underlying assets in this transaction are insurance premium finance receivables, not ABS interests.
D. Exemption for Securitizations of Assets Issued, Insured, or Guaranteed by the United States Government — § 246.19
The Risk Retention Rules exempt securitizations of assets that are issued, insured, or guaranteed by the United States or any agency of the United States (e.g., Ginnie Mae mortgage-backed securities, SBA loan-backed securities). This exemption is not applicable because the insurance premium finance receivables are not issued, insured, or guaranteed by the United States or any federal agency.
E. Exemption for Certain Foreign-Related Transactions — § 246.20
The Risk Retention Rules provide an exemption for certain securitization transactions in which (i) the ABS interests are not required to be and are not registered under the Securities Act, (ii) no more than 10% of the ABS interests are sold to U.S. persons, and (iii) the sponsor and issuing entity are not organized under the laws of the United States. This exemption is not applicable to this transaction. Although the offering is not registered under the Securities Act (it is a Rule 144A / Regulation S private placement), QIH is a Delaware corporation, QRF 2022-1 is a Delaware LLC, and the receivables are originated in the United States. Moreover, the majority of the ABS interests are expected to be sold to U.S. investors. The foreign-related transaction exemption is therefore unavailable.
F. Conclusion on Exemptions
Based on the foregoing analysis, no exemption from the credit risk retention requirements is available for the QRF 2022-1 securitization. The underlying assets (insurance premium finance receivables) do not fall within any of the asset-class-specific exemptions, and the transaction does not qualify for any of the other available exemptions. Accordingly, QIH, as the sponsor, must comply with the standard five percent (5%) retention requirement under the Risk Retention Rules.
VII. Compliance Structure — Detailed Requirements
A. Eligible Horizontal Residual Interest — Requirements (§ 246.4(b))
The Risk Retention Rules impose specific requirements on the structure and characteristics of an Eligible Horizontal Residual Interest (EHRI). We analyze each requirement below and assess compliance in the context of the proposed QRF 2022-1 structure.
1. First-Loss Position. The EHRI must be the most subordinated interest in the issuing entity and must absorb losses before any other ABS interest. The $15,000,000 overcollateralization / retained interest piece sits at the bottom of the QRF 2022-1 capital structure, below the Class C Notes (the most junior rated tranche). Under the sequential payment waterfall set forth in the Indenture, collections on the receivables are applied in the following order of priority:
• Step 1: Trustee fees and expenses
• Step 2: Servicing fee (1.00% per annum to QPF)
• Step 3: Class A Note interest
• Step 4: Class B Note interest
• Step 5: Class C Note interest
• Step 6: Class A Note principal (until paid in full)
• Step 7: Class B Note principal (until paid in full)
• Step 8: Class C Note principal (until paid in full)
• Step 9: Replenishment of overcollateralization to target level ($15,000,000)
• Step 10: Residual amounts to Issuer / retained by sponsor
The EHRI holder receives cash flows only at Steps 9 and 10 of the waterfall — after all trustee fees, servicing fees, note interest, and note principal have been paid. In the event of losses on the receivables, the EHRI absorbs those losses first, before any rated tranche is impaired. This confirms the first-loss/last-out character of the EHRI, satisfying the first-loss position requirement.
We note that the trustee fees and servicing fee, which are senior to all note interest and principal in the waterfall (Steps 1 and 2), are transaction expenses rather than ABS interests. The Risk Retention Rules require the EHRI to be subordinated to all ABS interests, not to all transaction expenses. The payment of trustee fees and servicing fees senior to the EHRI is consistent with the structure of the EHRI as the most subordinated ABS interest.
2. Fair Value ≥ 5% of Fair Value of All ABS Interests. As analyzed in Section V above, the fair value of the EHRI is expected to equal at least five percent (5%) of the fair value of all ABS interests issued by QRF 2022-1. Based on preliminary analysis, the estimated fair value of the EHRI is in the range of $28,000,000 to $35,000,000, which exceeds the approximate 5% threshold of $25,000,000.
3. Not Hedged or Transferred. The Risk Retention Rules (17 C.F.R. § 246.12) prohibit the sponsor from hedging or transferring the credit risk associated with the retained interest for the duration of the prescribed holding period. Specifically, the sponsor may not, directly or indirectly:
(a) sell, transfer, or otherwise dispose of the EHRI;
(b) enter into any credit derivative, total return swap, or other hedging arrangement that is designed to offset the credit risk of the EHRI; or
(c) pledge or finance the EHRI on terms that would effectively transfer the associated credit risk to a third party (though financing on a non-recourse basis may be permitted in limited circumstances under § 246.12(e), subject to significant conditions).
QIH must covenant in the transaction documents not to sell, pledge, hedge, or otherwise transfer the credit risk of the EHRI during the holding period. This covenant should be included in the Note Purchase Agreement and referenced in the Offering Memorandum.
B. Holding Period
The Risk Retention Rules prescribe a minimum holding period during which the sponsor must maintain the required risk retention. For non-RMBS transactions (including this transaction), the holding period extends until the later of:
(i) the date on which the total unpaid principal balance of the securitized assets has been reduced to thirty-three percent (33%) of the original unpaid principal balance at closing; or
(ii) two (2) years after the closing date of the securitization.
For this transaction, the holding period analysis requires consideration of the revolving period and amortization period:
• During the twenty-four (24)-month revolving period, collections on the receivables are reinvested in new eligible receivables, which maintains the pool balance at or near the initial level. The minimum pool balance during the revolving period is $450,000,000 (subject to early amortization triggers), which represents approximately 73.5% of the initial pool balance of $612,000,000. Accordingly, the pool balance is not expected to decline to 33% of the initial balance during the revolving period.
• During the twelve (12)-month amortization period following the end of the revolving period, the pool balance will decline as collections are applied to pay down the notes. Whether the pool balance declines to 33% of the initial balance during the amortization period depends on the speed of collections and the performance of the receivables. Given the short weighted average remaining term of the receivables (5.7 months), it is possible that the pool balance will decline to 33% of the initial balance before the end of the amortization period.
• The two-year anniversary of closing will occur approximately at the end of the revolving period (month 24). If the pool balance has not yet declined to 33% of the initial balance at that point, the holding period will extend beyond month 24 until the 33% threshold is reached.
In all scenarios, QIH must maintain the EHRI until both conditions are satisfied. We recommend that QIH's treasury and finance teams monitor the pool balance on a monthly basis and maintain records demonstrating compliance with the holding period requirement. The transaction documents should include covenants requiring QIH to retain the EHRI until the holding period expires and prohibiting any transfer or hedging of the EHRI during the holding period.
C. Disclosure Requirements — § 246.4(d)
The Risk Retention Rules require the sponsor to disclose the form, amount, nature, and material terms of the risk retention in connection with the securitization. The specific disclosure requirements are as follows:
1. Offering Memorandum Disclosure. The Offering Memorandum for the QRF 2022-1 transaction must include a dedicated section on risk retention that discloses the following information:
(a) The identity of the sponsor (QIH) as the entity retaining the required credit risk.
(b) The form of retention: horizontal risk retention through an Eligible Horizontal Residual Interest (EHRI).
(c) The par amount of the EHRI: $15,000,000.
(d) The fair value of the EHRI as determined at closing in accordance with GAAP ASC 820, together with a description of the methodology used for the fair value determination.
(e) The position of the EHRI in the payment waterfall, including confirmation that the EHRI is the most subordinated ABS interest and absorbs losses before any rated tranche.
(f) The prohibition on hedging, sale, or transfer of the EHRI during the holding period, including a description of the applicable holding period.
(g) Any material facts or circumstances that could affect the fair value of the EHRI or QIH's ability to comply with the risk retention requirements.
We recommend that a substantially final draft of the risk retention disclosure section be included in the preliminary Offering Memorandum (v3 dated October 12, 2022) and that the disclosure be finalized in the final Offering Memorandum at or prior to closing.
2. Post-Closing Reporting. The Risk Retention Rules contemplate that the sponsor will disclose material changes to the retained interest in periodic reports. Because this transaction is structured as a Rule 144A / Regulation S private placement and is not subject to the periodic reporting requirements of the Securities Exchange Act of 1934, the post-closing disclosure obligations are contractual rather than statutory. The Indenture and Servicing Agreement should include provisions requiring QIH (or QPF, as servicer) to include in the monthly investor reports a confirmation that QIH continues to hold the EHRI in compliance with the Risk Retention Rules, together with any material changes to the risk retention structure or any events that could affect QIH's compliance.
D. Documentation Requirements
The risk retention compliance structure must be reflected in the following transaction documents:
Note Purchase Agreement. The Note Purchase Agreement (between QRF 2022-1, QIH, and Ridgeline, execution draft v3 dated October 12, 2022) should include:
(a) A representation by QIH that it has retained, and will continue to retain during the holding period, the EHRI in compliance with the Risk Retention Rules, including 17 C.F.R. § 246.4(b).
(b) A covenant by QIH not to sell, pledge, hedge, or otherwise transfer the credit risk of the EHRI during the holding period.
(c) A representation by QIH regarding the methodology used for the fair value determination of the EHRI and confirmation that the fair value of the EHRI at closing equals or exceeds five percent (5%) of the fair value of all ABS interests.
(d) A representation that QIH is the "sponsor" of the securitization within the meaning of the Risk Retention Rules and that no other entity bears the retention obligation (or, if QPF is designated as a co-sponsor, appropriate representations regarding QPF's compliance).
Indenture. The Indenture (execution draft v4) should reference the retained interest and its subordination in the payment waterfall, and should confirm that the EHRI occupies the first-loss position. The Indenture should also include provisions consistent with the holding period and transfer restrictions applicable to the EHRI.
Offering Memorandum. As discussed above, the preliminary Offering Memorandum (v3 dated October 12, 2022) should contain a dedicated risk retention disclosure section. We will prepare an initial draft of this section for review by QIH's management and Ridgeline.
Servicing Agreement. The Servicing Agreement should include provisions requiring the servicer (QPF) to include in monthly investor reports a confirmation of QIH's continued compliance with the risk retention requirements.
E. Coordination with Ridgeline
Ridgeline Capital Markets LLC, as placement agent, has an independent obligation under the securities laws and market practice to verify that the sponsor complies with risk retention. Although the Risk Retention Rules impose the retention obligation on the sponsor (QIH) rather than on the placement agent (Ridgeline), Ridgeline's counsel — Harrison Collier and Megan O'Shaughnessy at Calloway & Brandt LLP — will need to confirm Ridgeline's comfort with the risk retention structure as part of Ridgeline's due diligence process and its preparation of the Offering Memorandum.
We recommend providing Harrison Collier and Megan O'Shaughnessy with a copy of this memorandum (subject to appropriate privilege protections, such as a common interest agreement) and affording them the opportunity to review and comment on our risk retention analysis. We further recommend scheduling a call with Ridgeline and Calloway & Brandt to discuss the risk retention structure, the fair value analysis, and the proposed disclosure in the Offering Memorandum.