CLO industry hits out at NAIC monitoring plan

Moves by the US National Association of Insurance Commissioners (NAIC) to bring CLOs under its scope is causing concern in the CLO industry.

The NAIC’s structured securities group is seeking the authority to model CLO investments instead of relying on a designation based on their external ratings. NAIC staff have cited their modelling of CMBS and RMBS holdings as a precedent. But Forrester says the process by which CMBS and RMBS modelling was instituted was different.

“In the wake of the global financial crisis, and the downgrades that beset CMBS and RMBS tranches, the American Council of Life Insurers petitioned the NAIC’s Valuation of Securities (E) Task Force for relief and proposed a modelling process that it and others had spent considerable time and resources developing,” says Forrester.

“By contrast, this initiative does not originate with an industry request for relief, will result in increased capital charges for insurers, and has not been preceded by the kind of analysis and testing that accompanied the CMBS/RMBS initiative.”

Forrester also points out that the NAIC fast-tracked plans to model CLOs. He says the 30-day comment period is short for a debate that will affect $200 billion of insurance investments. The comment period was due to end on 9 July, which is a Saturday.

However, the NAIC says the comment period has been extended. “The 30-day comment period/exposure is only on the issue paper and the exposure has been extended to Friday, July 15,” says an NAIC spokesperson. “The exposure period is the first step in a long process addressing the issue paper.”

Still, the original 30-day window included a couple of US public holidays and there are concerns that CLO market participants have not been given enough time to mount a defence of the asset class.

One CLO investor tells ­C­reditflux there is distrust in the CLO industry based on the severe stress testing the NAIC has applied to CLOs in the past. He claims the scenarios modelled are off-market.

“If some of these situations come to pass there will be carnage across financial markets. And even then CLOs would outperform,” he says.

Bank of America research has also criticised the NAIC plan. It points to flaws in the modelling process.

There are also questions about resources and whether the NAIC’s structured securities group is adequately staffed to monitor CLO investments, having effectively outsourced this to rating agencies previously.

The NAIC says in its proposal that it wants to stamp out regulatory arbitrage. It says a loan portfolio had a risk-based capital (RBC) factor of 9.54%, versus 2.92% across each tranche of a CLO backed by a similar loan pool. It has suggested introducing a new RBC factor of up to 100% for CLO equity.

Forrester says that some of the riskiest investments, such as venture capital equity, only attract an RBC factor of 30%.

He warns that CLO managers and investors may struggle to survive if the CLO proposals come into effect.

“If you cannot find investors to replace the $200 billion insurance company bid, you could be out of the market,” he says.