CLOs: NAIC prohibits third-party ratings on combo notes to determine risk capital
admin | February 7, 2020
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The National Association of Insurance Commissioners (NAIC) published regulatory guidance last week that forbids the use of third-party ratings to determine the risk capital for CLO combo notes, re-securitized from CLO debt and equity. In July 2019, the NAIC first proposed the requirement that CLO combo notes be rated only by the NAIC, arguing that the combo notes use rating arbitrage to hide the true risk of the underlying assets. Better ratings on combo notes have protected large insurers from higher capital charges. Since this proposal, domestic insurers’ interest in this product has faded, according to S&P. In November 2019, the NAIC agreed to delay and refine the rules for CLO combo notes at the urge of insurers. Last week, the NAIC re-published the proposal, explicitly citing CLO combo notes as a principal-protected note ineligible to use third-party ratings to estimate risk capital. It provides an example showing that the CLO combo note receives higher rating than that indicated by the WARF on all of its components. Moody’s stopped rating CLO combo notes after SEC charges in late 2018, and DBRS Morningstar opted out of rating CLO combo notes in December 2019. The S&P article is here (subscription required). (S&P, APS)
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