The NAIC’s Risk-Based Capital Investment and Risk Evaluation Working Group (RBC IRE WG) held a call on Monday to provide a progress report on the American Academy of Actuaries (Academy)’s model for CLO C-1 factors (i.e., the weight NAIC gives to each of its risk rating categories) for Risk-Based Capital (RBC) charges. While the model is operational it has not yet been finalized, and the Academy has identified areas where adjustments are necessary. The Academy anticipates releasing final factors, at the earliest, by April 30, 2026. (Note that at the NAIC Summer National Meeting in August the Valuation of Securities Task Force proposed an amendment to its Purposes and Procedures manual to postpone the implementation of a CLO RBC model from the end of this year to December 31, 2026 to allow the Academy additional lead time to complete its process.)
The Academy model currently includes just six deals. That said, the Academy noted that the results to date align with the model being developed by the NAIC’s Structured Securities Group (SSG), with tail risk concentrated in the junior debt tranches. Unlike the SSG model, which aims to determine C-1 factors for individual CLOs on a standalone basis, the Academy model seeks to assign C-1 factors to several risk buckets that are based on comparable attributes. Both use the Moody’s CLO library as the primary data source.
An important distinction of the SSG model as compared to the Academy model is their use of scenarios. The SSG model looks at 10 default and recovery scenarios that are probability-weighted to create tranche C-1 and collateral C-1 parity; the Academy model uses 10,000 equally weighted scenarios to estimate average losses for the worst 10% of those scenarios (i.e., a 10% tail ), without a bias to eliminating tranche C-1 and collateral C-1 differences.
The Academy’s approach is based on the American Council of Life Insurers and Moody’s C-1 model for corporate bonds with certain modifications to, among other things, account for the idiosyncratic nature of the sub-investment grade credit held in CLOs and variance in seniority of the collateral relative to most corporate bonds. The Academy’s model applies only to CLO debt tranches, given residual tranches require a specific C-1 methodology because of different accounting treatment.
The Academy’s modeling process has three parts. First, to ensure the above-mentioned risk buckets are precise and to identify their relevant attributes, the aggregate portfolio of loans in the CLO universe through is run through a collateral model, which evaluates defaults and recoveries of the portfolio. These defaults and recoveries are then run through a cashflow model that determines the resulting cash flows from the CLOs. The cash flows are then run through a C-1 factor model, which generates the C-1 CLO factors.
The Academy anticipates presenting important adjustments to their model by the end of the year of early 2026. These include: (i) the portfolio adjustment factor (which, in addition to individual tranche risk, takes portfolio diversification into consideration when determining capital charges), (ii) certain model refinements, and (iii) identifying potential comparable attributes and resulting factors. Potential changes to the model, and their impact on C-1 factors, include: (i) allowing for prepayment and reinvestment at less than par, which would reduce C-1 factors; (ii) adjusting the results for amortization of senior tranches, which would narrow the difference between the C-1 factors for senior and junior tranches; and (iii) identifying default timing patterns that result in larger CLO losses, which would increase C-1 factors.
Separately, the Academy will focus on incorporating any modifications requested by the NAIC in 1Q26.
