Willow Re downgraded again; will default on interest payment

It’s become apparent that Allstate‘s Willow Re catastrophe bond has been downgraded again by Standard & Poor’s due to a notice from Allstate that it is going to default on it’s scheduled interest payment. The rating on Willow Re Ltd.’s Class B 2007-1 series notes has been downgraded to ‘D’ from ‘CC’. An interest payment was due today, February 2nd. There’s a five day grace period before default is called but Allstate has notified S&P to say that it does not expect to have sufficient funds to make the interest payment.

This could harm confidence in the insurance-linked security market at a time when it is needed to help encourage investors to take stakes in the deals currently in the pipeline. As Willow Re Ltd. will have to be settled if it defaults on the interest payment, and the total return swap counterparty Lehman Brothers failed so is not available to make up any collateral deficiencies, investors risk not receiving their investment pricipal back. This could be a blow to the market at a time when investor confidence is essential. Issuers are going to have to choose swap counterparties very carefully and work to structure deals in such a way that investors feel issues such as counterparty security are being addressed.