SVO Once Again Object of Industry's Ire; This Time For Surprise on 'Hybrid Securities'

A phrase used Tuesday by those enraged as a result of recent NAIC Securities Valuation Office actions can be used to sum up their objections: "Regulatory event risk."

The SVO's recent action to classify a security as having characteristics of common stock caused issuers and holders of such securities to storm the barricades during the NAIC's summer meeting in Washington, D.C., to assert that both analytical procedures and dissemination of NAIC ratings or classifications are faulty or reckless.

A MetLife official suggested to the NAIC's Financial Condition (E) Committee Tuesday that it is "patently unfair" that his company may be worth $3 billion less as a result of the SVO action to "re-classify an identical product" in the hybrid security category as equity rather than debt.

Hybrid securities is a loose designation for a number of securities-industry products that may have characteristics of both debt and equity and are judged by the SVO as one or the other for the purpose of risk-based capital charges for insurers holding the securities in their portfolios.

The risk-based capital charge for securities classified as equity is a hefty 30 percent, and the crux of the protest heard during the NAIC meeting originated with holders or sellers of certain of these securities learning of the "equity" classification by the SVO and the consequent diminution of holders' regulatory capital. One specific security of this loose class is known as ECAPS, a trademark designation of Lehman Brothers, and it is one of those at the center of contention.

But that depression of value for insurers can also, as was loudly proclaimed to regulators, infect the broader market for such securities. The dispute between the SVO and others may also be regarded by other issuers or sellers as good reason to avoid issuing more of such securities.

Although the loose class of securities among insurers is held primarily by life companies, the storm of criticism of the SVO is more broadly significant as being another glitch in SVO function, an NAIC division that is frequently accused of incompetence.

The criticism at the summer NAIC meeting began Sunday during a meeting of the Valuation of Securities Task Force, where the committee's first attempt to deal with intense criticism was to "grandfather," as of Friday, the debt status of those hybrid securities that had been changed to equity. Also part of that first response was a promise to re-visit technical issues attendant on classifying the securities between debt and equity. Debt does not receive the heavy risk-based capital haircut assessed against equity.

The decision to try calling a truce was soon altered by the Task Force, however, to holding all previous actions in abeyance. The storm in the Task Force then blew on to the Tuesday meeting of the superior Financial Condition (E) Committee, which decided it would schedule a joint hearing of the VOS Task Force and the Capital Adequacy Task Force in the very near term. That joint meeting, said (E) Committee Chair and Virginia Commissioner Al Gross, would be for the purpose of assessing a capital charge for those securities in question.

A letter to the NAIC from the Bond Market Association and the American Council of Life Insurers remonstrates harshly against actions of the SVO, asserting that NAIC SVO classifications and ratings are "material information" to securities issuers and holders and must, per federal securities laws, have open and orderly publication. The letter also cited "unequal transmission" of information concerning classification of a similar security issues by Rabobank, which was initially reported as debt and then re-classified by the SVO as preferred equity.

The SVO and the industry have frequently been at odds, although the pitch of industry irritation has been especially high in the current objections centered on the hybrid securities.

Direct questions to NAMIC Financial Regulation Manager William Boyd.

Posted: Thursday, June 15, 2006 12:00:00 AM. Modified: Thursday, June 15, 2006 10:51:48 AM.

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