Tag: CLOs

The Impact of Rising Rates on U.S. Insurer Investments

Mary Pat Campbell

Link: https://content.naic.org/sites/default/files/capital-markets-special-reports-impact-of-rising-rates.pdf

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Excerpt:

As corporate bonds are mainly fixed rate, their relative value will decrease as floating rate investments
become more attractive with higher benchmark rates. That is, bond prices will fall as yields rise to make
them more attractive, given that their fixed-rate coupons will be lower. About half of insurer bond
investments are corporate bonds, and the vast majority of U.S. insurer corporate bond investments are
investment grade credit quality. From January 2022 to January 2023, the ICE Bank of America (BofA)
Investment Grade Corporate Bond Index, which measures the performance of investment grade
corporate debt, was down by about 14%.


Corporate bond yields have increased significantly since the beginning of 2022 with rising interest rates
and widening credit spreads. As of year-end 2022, investment grade and high-yield corporate bond
yields averaged 5.5% and 8.9%, respectively (refer to Table 1). Investment grade yields increased by
approximately 270 bps during 2022, while speculative-grade yields increased by about 370 bps.

Author(s): Jennifer Johnson and Michele Wong

Publication Date: 23 Feb 2023

Publication Site: NAIC Capital Markets Special Report

Collateralized Loan Obligation – Stress Testing U.S. Insurers’ Year-End 2021 Exposure

Mary Pat Campbell

Link: https://content.naic.org/sites/default/files/capital-markets-special-reports-clo-stressed-analysis-ye2021.pdf

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Excerpt:

The stress test analysis found that 1,114 U.S. insurers, with a surplus of about $1.2 trillion, held some
amount of CLO tranches modeled. Similar to last year’s stress testing results, we found that the losses on
insurers’ CLO investments that were modeled, even in the stressed scenarios, were highly concentrated.


To understand the impact of potential losses on insurers, principal loss (compare with Table 7) for
scenarios A, B, and C was divided by each insurer’s year-end 2021 total surplus. For each scenario, the
principal loss as a percentage of total surplus for each of the 1,114 insurers was sorted from highest to
lowest. Then the insurer with the largest percentage loss was referenced as “Insurer 1,” the insurer with
the second largest percentage loss was referenced as “Insurer 2,” and so on until the smallest percentage loss, which was referenced as “‘Insurer 1,114” (x-axis). Please note the difference in the scale of the y-axis
in Charts 1, 2, and 3.


Chart 1 shows the distribution of losses as a percentage of surplus for December 2021’s Scenario A.
Although the bulk of insurers show no losses, 49 of the 1,114 insurers experienced losses in this
scenario. Intuitively, the losses were derived primarily from CCC-rated CLO tranches. The largest loss as
a percentage of surplus under Scenario A was 9.72%. Similar to the analysis for year-end 2020, no
insurers experienced double digit losses.

Author(s): Jean-Baptiste Carelus, Eric Kolchinsky, Hankook Lee, Jennifer Johnson, Michele Wong, Azar Abramov

Publication Date: Jan 2023

Publication Site: NAIC Capital Markets Special Reports

Insurance Companies and the Growth of Corporate Loan Securitization

Mary Pat Campbell

Link:https://libertystreeteconomics.newyorkfed.org/2021/10/insurance-companies-and-the-growth-of-corporate-loan-securitization/

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Excerpt:

The rating-based mapping was partially altered in 2010, when the NAIC enacted a regulatory change that essentially allowed insurance companies to report CLO tranches that were purchased at a discount, or highly impaired, in a lower NAIC category than that implied by the rating-based mapping. The new capital regime for CLO investments likely increased insurance companies’ incentives to invest in higher-yielding CLO tranches.

The following chart presents some evidence consistent with reach-for-yield behavior, particularly since the regulatory reforms of 2010. The left panel shows the time series of insurers’ new CLO holdings falling into the NAIC 1 designation as a percentage of the total volume outstanding of these tranches based on percentiles of the distribution of CLOs yields for each year. As expected, there is a clear preference for the riskiest tranches within NAIC 1 (those with yields above the 66th percentile) throughout the sample period, with the exception of the financial crisis, when all yields are squeezed at their minimum levels. Interestingly, the market shares of CLO tranches with yields above the 33rd percentile experience a sharp increase in the two years following the 2010 regulatory reform, then register a significant drop in 2019, when the reform was repealed. We do not find similar evidence in insurance companies’ corporate bond investments (right panel).

Author(s): Fulvia Fringuellotti, João A. C. Santos

Publication Date: 13 Oct 2021

Publication Site: Federal Reserve Bank of New York

Libor Transition Stokes Sales of Risky Corporate Debt

Mary Pat Campbell

Link: https://www.wsj.com/articles/libor-transition-stokes-sales-of-risky-corporate-debt-11631451601

Excerpt:

Managers of collateralized loan obligations — securities made up of bundled loans with junk credit ratings — are rushing to close deals ahead of the year-end move away from the London interbank offered rate. The interest-rate benchmark underpins trillions of dollars of financial contracts but was scheduled for phaseout after a manipulation scandal.

That is helping push CLO sales to records. U.S. issuance topped $19.2 billion in August, a monthly record in data going back a decade, according to S&P Global Market Intelligence’s LCD.

…..

A wave of CLO refinancings this year allowed some managers to include fallback language shifting to SOFR in their documents, analysts said. But for other deals, CLO managers and investors must negotiate that changeover, which could create conflicts if they have different rate preferences.

Disruptions to the transition could increase the extra yield, or spread, that investors’ demand to hold triple-A rated CLO debt during the fourth quarter of this year, depending on how quickly the loan market transitions and how new CLO deals and investors position themselves, said Citi analysts in a June note.

SOFR is based on the cost of transactions in the market for overnight repurchase agreements, where large banks and hedge funds borrow or lend to one another using U.S. Treasurys as collateral. Unlike Libor, which tends to rise during periods of market stress, it doesn’t adjust for shifts in credit.

During last year’s spring selloff, the difference between three-month Libor and SOFR rose to 1.4 percentage points at its peak, according to BofA. That means CLO debtholders received a higher rate than what they would have if their bonds were linked to SOFR.

Author(s): Sebastian Pellejero

Publication Date: 12 September 2021

Publication Site: Wall Street Journal