Another Tailwind for Credit Risk Transfer?
In a recent paper, we highlighted the benefits of allocating to Credit Risk Transfer (CRT) in multi-sector fixed income and securitized credit portfolios. CRT securities are floating-rate instruments that deliver minimal duration risk, credit spreads in excess of many fixed income sectors and, ultimately, the potential to increase risk-adjusted returns across a wide range of economic scenarios. In addition to these diversification benefits, investors in CRT securities can gain focused, direct exposure to U.S. housing markets and homeowners.
Recent developments in the insurance space may provide the CRT sector with yet another boost. The National Association of Insurance Commissioners (NAIC) released its 2016 designations for CRT securities. For participating insurance company investors, these designations govern the regulatory capital required to be held against CRT instruments.
Prior to the NAIC’s recently released score update, the ratings designations for the CRT universe were limited to transactions where the severity associated with potential defaults was set at a fixed percentage, presumably enabling greater certainty in loss modeling by the NAIC. While the vast majority of these fixed severity transactions had been afforded NAIC 1 status, the non-fixed severity portion of the CRT universe had not been scored under this methodology.
In its 2016 release, the NAIC included inaugural loss modeling of non-fixed severity transactions, covering all transactions with greater than 15 months of seasoning and/or issued before September 16, 2016. The distribution of these new and updated designations are predominantly NAIC 1 (84%), followed by NAIC 2 (9%), corresponding with relatively low associated regulatory capital requirements for insurers. The remaining 2 scored bonds received NAIC 3 designations (2%) with just 5% of the universe not scored.
These scores are expected to encourage additional insurance company participation in CRT-related investment activity, which should be a positive for liquidity dynamics in the CRT sector going forward.
Source: National Association of Insurance Commissioners (NAIC). Represents 2016 NAIC ratings for non-fixed severity transactions, covering all transactions with greater than 15 months of seasoning and/or issued before September 16, 2016.