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syndicated bank loans (usually at least 90% of the total portfolio); and it may include a pre-determined
allowable portion of other asset types, such as second lien bank loans (which are highly leveraged) and
unsecured debt, as well as middle market loans. Some CLOs consist predominantly of middle market
loans as the underlying collateral.
The average rating of the underlying collateral is typically about single-B, and the leveraged bank loans
are typically floating rate, based on London Inter-bank Offered Rate (LIBOR). In addition, there is also an
allowance for leveraged bank loans that are “covenant-lite” (cov-lite)—that is, those that do not have as
many restrictions relative to the borrower’s debt-service ability as typical bank loans.
Cov-lite loans with “loose” or no financial maintenance covenants have been on the rise in recent years,
peaking at $742 billion outstanding in 2017 (double the amount in 2016), according to FitchRatings
research. By the end of 2018, cov-lite represented about 80% of all leveraged loans according to S&P
Global Market Intelligence’s Leveraged Data & Commentary unit, and there were about $922 billion in
cov-lite loans as of January 2019.
CLO Stress Methodology
Because of recent regulatory interest in leveraged bank loans and CLOs—due in part to the loosened
underwriting standards on the underlying leveraged bank loans (such as the increase in cov-lite, along
with a lack of subordination and weaker earnings-before-interest-tax-deprecation-and-amortization
(EBITDA) multiples with leveraged bank loans)—the NAIC Structured Securities Group (SSG), along with
the Capital Markets Bureau (CMB) performed a series of stress tests on U.S. insurer holdings of CLOs as
of year-end 2018. Three scenarios were formed, each with increasing conservatism. Note that a
probability of occurrence was not assigned to any of the stress test scenarios—these scenarios are not
meant to value the securities. The goal was to measure the potential impact of CLO distress on
insurance company balance sheets.
The NAIC endeavored to model all tranches of broadly syndicated CLOs held by U.S. insurers at year-end
2018. Excluded were CLOs securitized by middle market loans and commercial real estate; collateralized
debt obligations (CDOs) collateralized by asset-backed securities (ABS) and trust preferred securities
(TruPs); and collateralized bond obligations (CBOs) and resecuritizations. It is, however, the NAIC’s
intention to stress test middle market CLOs at a later date.
Stress Thesis
Our Stress Thesis is that the consequences of less stringent underwriting on the underlying bank loan
collateral will result in substantially lower recovery rates during the next recession. Specifically, the
stress tests aim to show how CLOs would fare if bank loan recoveries deteriorated from historical norms
as compared to unsecured debt recoveries. In addition, the recovery stress scenario was run under both
a historical and a moderately stressful default environment.