The National Association of Insurance Commissioners has extended the comment period over a proposal to revise risk-based capital (RBC) charges on CLO holdings of carriers, a change that market observers say could deter insurance company investments in lower-rated CLO debt notes.
Meredith Coffey, executive vice president of the Loan Syndications & Trading Association, said in a commentary posted to the LSTA website on Thursday that the NAIC proposal originally drafted on May 25 could “materially reduce insurance companies’ appetite for CLOs” by increasing the highest risk capital charges on the mezzanine note and equity stakes in CLOs.
A research report last week from BofA Securities concurred, noting that carriers will likely not support the proposal as written given the apparent disadvantage the plan would hold for investing in lower-rated bond tranches of the CLO capital stacks.
The NAIC proposal “would impact mezz & equity RBC factors the most,” the report stated. "[W]e think many insurance companies are likely to oppose it.”
Insurance companies represent one of the largest bases of investors in non-AAA notes, holding more than half of the CLO market’s universe of single-A and BBB rated CLO liabilities, according to Coffey. NAIC figures show insurance companies have built their CLO investments to $193 billion (a 2020 figure). Insurance company CLO investments have also spurred the rise of insurer-affiliated CLO managers.
“If these notes—particularly BBB notes—become less attractive to insurance companies, there could be ramifications for CLO originations generally,” Coffey wrote. “On a more individualized basis, insurance companies hold more than $10 billion of CLO equity, oftentimes related to investments in their CLO manager affiliates. If CLO equity investments attract materially more RBC, this could impact the universe of insurance-affiliated CLO managers.”
In a draft of the proposal, the NAIC stated that it wants to eliminate the RBC “arbitrage” benefit insurers gain through lower-cost RBC on loan securitizations over direct investments in loans, despite the fact that a purchaser carries “the exact same investment risk” in either scenario. In an example provided in the memo, a pool of B rated loans requiring a 9.535% RBC factor would only need an overall RBC factor of 2.917% if pooled into a CLO.
“The aggregate risk-based capital (RBC) factor for owning all of the CLO tranches should be the same as that required for owning all of the underlying loan collateral,” the NAIC memo stated.
The NAIC has extended the comment period through July 15 for the proposal. The LSTA, which formally requested an extension through Aug. 26, has formed a new working group to construct a response to the NAIC proposal.
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