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August 2022 | Issue 248

Investors disagree on impact of NAIC’s CLO modelling proposal

Sayed Kadiri headshot
Sayed Kadiri
A split is forming among insurance-backed CLO investors, with some not concerned by the National Association of Insurance Commissioners’ CLO proposals.
The NAIC plans to model CLO investments itself, rather than rely on public ratings. This is likely to imply higher capital charges for junior CLO debt and equity investments.
Creditflux has reported on concerns raised by CLO market participants — namely Bank of America and the Loan Syndications & Trading Association.
But Francisco Paez, head of structured products research at MetLife Investment Management, says there is not enough information on the NAIC’s modelling methodology to judge it. He has worked with the NAIC on its CMBS and RMBS models and takes comfort from that process.
“If done properly, a model-based methodology for assessing CLO capital charges is reasonable,” he says. Another CLO investor at an insurance firm agrees with this sentiment.
“CLO triple Bs are likely to remain a competitive product”
Francisco Paez, Head of structured products research | MetLife Investment Management
For CMBS and RMBS exposures held by insurance companies, the NAIC assigns a capital charge at the end of each year. While risk-based capital based on modelling is likely to decline for securities that eventually de-lever, like CLOs, this weighting is unlikely to change drastically over time for CMBS, as these structured products tend to have a near bullet-like amortisation profile.
Estimating the capital charge for a new security at year-end is fairly straightforward, says Paez, given the vast amounts of CMBS and RMBS bonds than the NAIC has modelled over the past decade.
Paez thinks CLO tranches rated triple A to single A are unlikely to be adversely affected by the proposals. Triple B and lower-rated CLO investments may be impacted, but even then insurers’ appetite for such assets may not alter, he says.
“The way an insurer thinks about the capital charge is not on an absolute basis,” says Paez. “If you have a higher capital charge on a CLO triple B note, then it will be less attractive than it is today — but it could still be appealing versus similarly-rated alternatives. On that basis, CLO triple Bs are likely to remain a competitive product.”
The second CLO investor says the NAIC proposals largely affect insurers who buy higher yielding paper. If CLO triple Bs are made less attractive for insurers, he says they may move up the capital stack.
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Global credit funds & CLO's
August 2022 | Issue 248
Published in London & New York.
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