ART Special Report – February 14, 2023
Benchmarking the Treatment of CLOs
The proposed model-based designations for CLOs, and the broader move away from agency ratings, is resolving in some dimensions and increasingly uncertain in others. With the NAIC and regulators citing concerns over rating agency commercial interests biasing risk assessments and the appropriateness of using agency ratings in capturing tail risks, questions remain over what designations are intended to measure, and the degree to which the proposed intrinsic-price approach is an improvement. This report benchmarks the performance of NAIC intrinsic price designations against market-based measures, and explores the lessons learned from the treatment of structured assets across regulatory jurisdictions. We find that:
Intrinsic-price-based designations benchmark poorly to market spreads when compared to agency ratings. Despite data quality limitations, our analysis suggests the poor performance is, in part, inherent with the methodology whereby credit will generally receive higher quality designations as it approaches maturity. This maturity effect is a departure from the C1 framework, and can result in shorter dated, high-spread credit with low quality agency ratings (e.g., BB or B) assigned high quality intrinsic price designations (e.g., 1.a or 1.d)
Other regulatory frameworks often differentiate credit across agency rating categories and remaining maturity.Our estimates suggest remaining maturity may receive more punitive capital treatment under intrinsic-price-based NAIC designations than any other regulatory framework explored, including Solvency II and IAIS ICS
Critical to the discussion, we provide possible approaches that can more closely align the intrinsic price approach with the C1 RBC framework and identify characteristics that are associated with assets whose designations benchmark poorly, which can be used as a starting point for a more comprehensive study that can be used by the NAIC to improve upon their methodologies.
We hope you find this resource helpful – it is consistent with our goal of bringing value to our community.
Amnon Levy and Brett Manning
Our report, Benchmarking the Treatment of CLOs, was recently featured in Green Street's Asset Backed Alert!