Queen Street III Capital Ltd.

Queen Street III Capital Ltd. issued $150m of notes in a single tranche which provide Munich Re with cover on a per-occurrence basis over a three-year period against certain European windstorms.

The deal runs for three years and expected maturity is in July 2014, with the chance to extend for losses to develop in three-month increments for up to two years.

The notes cover major windstorms in the following countries; Belgium, Denmark, France, Germany, Ireland, Luxembourg, The Netherlands and the UK.

For a windstorm event to qualify under the terms of the cat bond deal and hit the industry loss trigger point, they must result in an index value of above 10,000 up to an index value of 15,000. The index will be calculated by risk modeller AIR Worldwide using industry loss data provided by PERILS AG, enhanced by industry exposure data provided by AIR Worldwide.

Each year Munich Re can choose whether to reset the windstorm payout factors while the industry exposure data must be reset. AIR Worldwide will reset attachment and exhaustion points annually on the 15th June so that the new attachment probability and expected loss are equal to or less than the initial one-year attachment probability and the initial one-year expected loss for Europe windstorm. Interestingly there is a reset limitation which means that the contribution to the expected loss for storms hitting France, Germany and the UK combined cannot be less than 70%.

Ratings agency S&P say that storm surge is a significant risk to European windstorm cat bonds. They point out that of the 299 modelled storms 13 would have caused a principal loss to this cat bond through storm surge damage affecting the UK. Something for issuers and risk modelling firms to consider as storm surge is not well modelled across Europe.

Munich Re have established a new collateral fund specifically for this transaction. MEAG Queen Street III, which will be managed by a Munich Re subsidiary, was rated by S&P two days ago and is destined to hold the collateral for this transaction which will comprise highly rated U.S. Treasury bills.

This deal tripled in size having begun marketing at $50m it ended up closing at $150m due to investor demand.

Update 30th October 2013: Due to the uncertainty surrounding the U.S. debt ceiling, on October 11th the MEAG Queen Street III fund saw a decline in its per-unit mark-to-market value. As the fund is designed to hold the collateral until the cat bond matures or a payout is required the fund faces strict asset value guidelines which state that the per-unit value may not fall below $100.00.

Because the per-unit value fell below this guideline amount the indenture trustee, Bank of New York Mellon, requested the liquidation of the fund and reinvested the remaining assets into Federal U.S. cash reserves. The proceeds from the liquidation amounted to $149,969,566.47, resulting in a loss of principal of $30,433.53, or two basis points).

As a result of this loss of collateral there is now a chance that the Queen Street III Capital cat bonds investors will not receive their full principal on maturity of the notes. As a result of this, ratings agency Standard & Poor’s placed its ‘B+ (sf)’ rating on the $150m of notes issued by Queen Street III Capital on CreditWatch negative.

S&P said; “The CreditWatch placement reflects that there is a one-in-two chance of a downgrade to ‘CC (sf)’ in the next three months if we consider there is a high probability that the noteholders will not receive 100% of the $150 million principal originally deposited in MEAG Queen Street III.”

S&P said it may affirm the rating at ‘B+ (sf)’ if it believes that the probability of a loss of principal by the maturity date is low. This will depend on whether the collateral is able to be invested in assets which could increase in value or whether, perhaps, the issuer could elect to top-up the collateral account to $150m again.

Update February 2014: Queen Street III Capital Ltd., was placed on CreditWatch over two months ago due to concerns that investors could face a reduction in capital returned after the cat bond suffered a loss of principal in the collateral account due to a decline in the collaterals per-unit mark-to-market value.

The reason for the loss of value in the collateral assets was due to the uncertainty created by the U.S. debt ceiling issue. The collateral trust fund saw a decline in per-unit mark-to-market value. The fund was designed to hold the collateral until the cat bonds matured or a payout was required, meaning that the funds faced strict asset value guidelines which stated that the per-unit value could not fall below $100.00.

Because the per-unit value of the fund fell below this guideline amount the indenture trustee, Bank of New York Mellon, requested the liquidation of the funds and reinvested the remaining assets into Federal U.S. cash reserves.

For the Queen Street III cat bond the proceeds from the liquidation amounted to $149,969,566.47, resulting in a loss of principal of $30,433.53, or two basis points and the proceeds were reinvested in the same way.

Standard & Poor’s said that the reinvested assets are not expected to regain their original net asset value. As a result S&P now believes that investors in the cat bond transactions face a heightened risk that they will not receive back 100% of the outstanding principal amount on the redemption date for each cat bond.

As a result S&P has downgraded its rating on the $150 million principal-at-risk variable-rate notes issued by Queen Street III Capital to ‘CC (sf)’ from ‘B+ (sf)’. Thenotes have been removed from CreditWatch negative status.

S&P explained; “Since we received the notice of default, we have monitored the performance of the Federated U.S. Treasury Cash Reserves in which the proceeds have been reinvested, and we consider that it is unlikely that the fund will regain the original net asset value on the redemption date.”

S&P also noted; “Moreover, the transaction structure does not ensure that noteholders will receive back 100% of the outstanding principal amount when the notes redeem.”

For the Queen Street III Capital Ltd. cat bond S&P said there would be a shortfall of $28,374.65 on the return of principal to investors at redemption date and that it also expects to downgrade this cat bonds rating to ‘D (sf)’ (Default) from ‘CC (sf)’ on July 28th 2014, when we anticipates investors will receive back $149,969,566 of the original $150m principal.