The NAIC’s Capital Markets Bureau monitors developments in the capital markets globally and analyzes their

potential impact on the investment portfolios of U.S. insurance companies. Please see the Capital Markets Bureau

website at INDEX.

Commercial Real Estate Collateralized Loan Obligations

Primer

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What are CRE CLOs?

CRE CLOs are CLOs that are collateralized by CRE loans that are transitional, or short-term and floating

rate. Income earned on the underlying CRE loans—i.e., principal and interest payments—is utilized to

make debt service payments to noteholders. Due in part to the strong U.S. economy and investor

appetite for higher yields, the CRE CLO market experienced substantial growth in 2019. Some sources

Characteristics of the Underlying CRE Collateral

Collateral for CRE CLOs primarily consists of bridge loans (short-term loans) on CRE properties that are in

transition, such as renovations, expansion, or repositioning. They are “transitional” loans on properties

that will have more value in the future and are not seeking long-term financing. The transitional loans

typically have a duration of three to five years and are floating rate. In addition, they are predominantly

whole loans and pari passu participation whole loans secured by first-mortgage liens on CRE assets.

In contrast, CMBS are structured finance transactions collateralized by stabilized property loans; i.e.,

those that have achieved an occupancy rate of at least 80%. Chart 1 shows the difference in collateral

and structural characteristics between a CRE CLO and CMBS, including statistics from 2020.

Fall 2014.

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Chart 1:

to the investment grade-tranche(s). There is also a bottom-most equity layer, or first-loss position, that

remains with the agent that originated the underlying portfolio of CRE loans. Structurally, the first-loss

party investor that has not contributed to the asset pool. CMBS tend to be static transactions, in that

once loans are identified for the pool, they are not swapped out during a reinvestment period, and the

principal on the notes issued to CMBS investors is paid down as the underlying commercial mortgage

loans mature (also known as amortization). CRE CLOs on the other hand, may be static or managed

transactions, meaning the manager of the underlying CRE pool may remove and acquire loans at its

discretion during a specified reinvestment period (as is the case with “traditional” CLOs). Just like CLOs,

after the reinvestment period, principal proceeds from CRE loans pay down principal on the notes issued

to investors. Also like CLOs, CRE CLOs may have a ramp-up period, during which time CRE loans are

acquired for the portfolio prior to closing. In addition, CRE CLOs have overcollateralization and interest

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coverage tests and collateral quality tests that must be satisfied as loans are substituted within the

portfolio during the reinvestment period.

Depending on investment strategy and philosophy, CRE CLOs represent attractive investment options

when risk/reward opportunities may be challenging. Most CRE CLO notes within the U.S. insurance

industry are held by life companies.

What Are the Risks?

Similar to traditional CLOs collateralized by leveraged bank loans, CRE CLOs have credit risk; i.e., risk that

the underlying portfolio of CRE loans will not be able to generate sufficient cash flow to pay investors

when principal and/or interest payments are due. This potential payment default can be influenced by a

few factors, one of which is the CRE loan market in general. This means it is important for CLO managers

to take notice of any issuers and/or property types that are experiencing difficulties or challenges in the

current environment as they are making investment decisions. Default in payment on the CRE loans

investors. Note that the CRE CLO note is typically floating rate as well, so interest owed to the

noteholders will also increase as rates rise.

with effectively managing CLO structures to the best interest of all investors.

U.S. Insurers and CRE CLOs

For reporting and statutory accounting purposes, CRE CLOs typically fall into the category of loan-backed

and structured securities (LBASS). LBASS are generally issued by special-purpose corporations or trusts

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(issuer) established by a sponsoring organization. According to the Accounting Practices and Procedures

Manual (AP&P Manual), “loan-backed securities are defined as securitized assets not included in

structured securities…for which the payment of interest and/or principal is directly proportional to the

payments received by the issuer from the underlying assets, including but not limited to pass-through

securities, lease-backed securities, and equipment trust certificates.” If a CRE CLO is defined as an LBASS,

then it follows the guidance of Statement of Statutory Accounting Principles (SSAP) No. 43R—Loan-Backed

and Structured Securities. SSAP No. 43R securities are reported on Schedule D, Part 1: Long-Term Bonds,

as LBASS with NAIC designations 3 through 6 are to be reported at the lower of amortized cost or fair

value.

LBASS meet the definition of assets as defined in SSAP No. 4—Assets and Nonadmitted Assets, and they

are admitted assets to the extent that they conform to the requirements of SSAP No. 43R. CRE CLOs have

typically been a relatively small subset of the U.S. insurance industry’s overall CLO exposure, which has

predominantly been to CLOs securitized by BSLs. Also similar to insurers’ BSL CLO investments, CRE CLO

investments have been high credit quality.

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Appendix:

CRE CLO Issuance (YTD = April 2021)

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Credit Enhancement

Also referred to as “overcollateralization,” it is the ratio of the aggregate principal value of pooled assets

to the outstanding debt (tranches) that make up the capital structure.

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Special Purpose Vehicle (SPV)

Trusts whose operations are limited to the acquisition and financing of specific assets into the pool that

collateralizes the structured securities (in this case, CRE CLOs); an SPV is the actual issuer of the CRE CLO

notes.