Alamo Re Ltd. (Series 2015-1)

This 2015-1 Alamo Re cat bond deal is again being brought to market with the assistance of German reinsurer Hannover Re, acting as the ceding reinsurer in the transaction. TWIA will enter into a reinsurance agreement with Hannover Rück SE and then enter into a retrocession agreement with Alamo Re Ltd. to effect the transaction.

Alamo Re Ltd. will seek to issue two tranches of Series 2015-1 notes, with a total initial size of $450m, a $200m Class A tranche of notes and a $250m Class B tranche.

The proceeds of the sale of the notes will be used to collateralize the underlying reinsurance agreements and ultimately provide TWIA with a source of reinsurance protection for named storm risks (so tropical storm and hurricane) in the State of Texas.

The Alamo Re 2015-1 cat bond will provide its protection using an indemnity trigger and on an annual aggregate basis. The Class A tranche of notes will cover TWIA for three years, while the Class B tranche will provide four years of protection.

The $200m Class A tranche of notes are the riskier of the two, with an attachment point at $2.6 billion of losses and an exhaustion point at $3.2 billion. That is equal to an initial attachment probability of 2.74%, an initial exhaustion probability of 2.14% and an initial expected loss of 2.46% base case (2.68% sensitivity case). These notes will provide TWIA with coverage until June 2018.

The $250m Class B tranche of notes attach at $4 billion of losses and exhaust at $4.8 billion. That equates to an attachment probability of 1.61%, an exhaustion probability of 1.3% and an expected loss of 1.42% at the base case (1.58% sensitivity case). These notes cover TWIA until June 2019.

Launch price guidance has been set at 5.4% to 5.9% for the riskier Class A notes, suggesting a multiple of at least 2 times the sensitivity case expected loss, and 4.25% to 4.75% for the Class B notes, suggesting a multiple of at least 2.6 times the expected loss.

The pricing is a little lower than that seen in 2014, as you’d expect, however the multiples to expected loss remain roughly aligned between the 2014 Alamo Re and the proposed pricing levels of the 2015 cat bond, even at the lower end of pricing.

TWIA has split the coverage from this cat bond into two layers, which will allow it to spread the fully collateralized, catastrophe bond sourced component of its reinsurance programme within its tower. That’s a sensible move from a diversification of risk capital point of view, something that is important to insurers like the Texas Windstorm Insurance Association.

The Alamo Re Ltd. (Series 2015-1) catastrophe bond is being brought to market by sole structuring agent and bookrunner GC Securities, while AIR Worldwide is risk modeller.

Update 1:

The Alamo Re 2015-1 cat bond upsized significantly, by almost 56%, to $700m in total size before close.

The Class A tranche of notes grew by 50% to $300m and the Class B tranche by 60% to $400m.

Pricing settled at or near the upper end of initial guidance.

The Class A notes pricing settled at 5.9%. With an expected loss of 2.46% base case (2.68% sensitivity case) that suggests a multiple of 2.4x at the base case, 2.2x sensitivity case.

The Class B saw pricing just below the top end of guidance, at 4.6%. With an expected loss of 1.42% at the base case (1.58% sensitivity case), the multiple looks likely to be 3.2x at the base case, 2.9x sensitivity case.

Fitch Ratings had the following to say on the 2015-1 Alamo Re cat bond in a pre-sale announcement:

Fitch Ratings expects to rate the Series 2015-1 Principal At-Risk Variable Rate Notes issued by Alamo Re Ltd., a registered special purpose insurer in Bermuda, as follows:

–Class A Notes expected to mature Jun. 7, 2018 ‘B+sf’; –Class B Notes expected to mature Jun. 7, 2019 ‘BB-sf’;

The Rating Outlook for each class within the Series 2015-1 Notes is Stable. Neither the principal amounts nor the risk interest spreads have been determined.

Fitch has also placed on Rating Watch Positive, the ‘Bsf’ rating for the Alamo Re Ltd. Series 2014-1 Class A Principal At-Risk Variable Rate Notes expected to mature Jun. 7, 2017, in connection with the Reset Report dated April 3, 2015 which has outlined the election to lower the annual attachment probability of the Series 2014-1 Notes, effective as of the first Reset Date, June 1, 2015.

TRANSACTION SUMMARY

The Series 2015-1 Class A and B Notes provide multi-year protection for the Subject Business written by the Texas Windstorm Insurance Association (TWIA) on an annual aggregate basis using an indemnity trigger. The notes are exposed to insured property losses due to ‘named storms’ within the covered area, which solely covers the 14 first-tier, coastal counties of Texas (and a small portion of Harris County). The Subject Business represents a total insured value of $86.9 billion (as of Dec. 15, 2014) and consists of residential coverage (86.3%), commercial coverage (13.6%) with very minimal mobile home coverage (0.1%). Galveston and Brazoria counties represent approximately half of the total insured value with 30.2% and 19.6%, respectively.

Series 2015-1 Class A noteholders are subject to principal loss (and reduced interest) if annual aggregate ultimate net losses exceed the initial attachment level of $2.6 billion and a total loss of principal occurs if the annual aggregate ultimate net losses reach the reach the initial exhaustion level of $3.2 billion in the first 12-month risk period. The Series 2015-1 Class B Notes have an initial attachment level of $4.0 billion and an exhaustion level of $4.8 billion. A named storm must generate at least $50 million in ultimate net losses to be included in the aggregate totals. Based on the profile of the subject business and the attachment level, the third party modeling firm AIR Worldwide (AIR) calculates the modeled annual attachment probability on the Series 2015-1 Class A Notes to be 2.74%, which implies a ‘B+sf’ rating per Fitch’s criteria. The Series 2015-1 Class B Notes have an initial probability of attachment of 1.61%, which implies a ‘BB-sf’ rating.

Fitch currently rates the Alamo Re Ltd. 2014-1 Class A Notes at ‘Bsf’ and has received notification from AIR, which serves as the Reset Agent, that the modeled attachment probability of the transaction will be lowered to 2.09% from its initial annual attachment probability of 3.80%. The reset will move the attachment level of the 2014-1 Class A Notes up to $3.2 billion from the initial attachment level of $1.9 billion and will increase its insurance percentage to 50% of its respective layer, up from approximately 30%. As of the Reset Date, June 1, 2015, the Series 2014-1 Class A Notes are expected to be layered in between the Series 2015-1 Class A and Class B Notes. AIR has also recalculated the risk interest spread for the 2014-1 Class A Notes, which is expected to decrease to 5.24% from the initial spread of 6.35%.

TWIA will retain at least 5% of the aggregate ultimate net loss on a first-dollar basis, covering the first $600 million. Above this retention, the company has the ability to issue up to $2.5 billion of public securities funded by premium surcharges to policyholders and assessments on TWIA member companies. Above the modeled attachment level for the Series 2015-1 Class A Notes of $2.6 billion, claim losses are shared between noteholders and traditional reinsurers up to $3.2 billion on a pro-rata basis depending on the ultimate deal size.

After the Series 2015-1 Class A Notes are exhausted, the Alamo Re Ltd. Series 2014-1 Class A Notes are expected to have an attachment level of $3.2 billion and share 50% of aggregate ultimate net losses with traditional reinsurers up to $4.0 billion.

The Series 2015-1 Class B Notes then have an attachment level of $4.0 billion and share aggregate ultimate net loss between its noteholders and traditional reinsurers up to $4.8 billion on a pro-rata basis depending on the ultimate deal size.

On a historical basis, there have been 37 hurricanes that have made landfall in Texas since 1900. Recent hurricanes, Dolly and Ike (two events in 2008) and Rita (2005) would not have caused a principal loss to either the Series 2015-1 Class A or Class B Notes. Modeled results for four hurricanes prior to 1933 would have totally exhausted the 2015-1 Class A Notes. The Series 2015-1 Class B Notes would only have been exhausted by the nameless storm that occurred in 1900, while the nameless storm of 1915 would have caused a 63.6% principal loss.

There are three annual risk periods for the Series 2015-1 Class A Notes and four for the Series 2015-1 Class B over the term of the notes. The Series 2015-1 Notes will reset on June 1, 2016 and June 1, 2017 (as well as June 1, 2018 for 2015-1 Class B) using AIR’s escrowed software models and TWIA’s updated subject business data. At each reset date, TWIA may exercise an option to decrease (or increase) the respective attachment levels on each of the classes within an exceedance probability range of 4.40% to 1.00%. The implied rating under Fitch’s criteria at a 4.40% exceedance probability is ‘Bsf’, and the implied rating at 1.00% is ‘BB-sf’. If such an option is exercised by TWIA at either reset date, the applicable risk interest spreads will be recalculated to reflect the increased (or decreased) level of risk assumed by the noteholders. If TWIA does not elect to reset the attachment level, the reset agent will adjust the respective attachment level to maintain the initial exceedance probabilities using the updated subject business profile.

The applicable Class of Series 2015-1 notes may be extended for thirty-six additional months if certain qualifying events occur, or at the discretion of Hannover Ruck SE, a reinsurance company that acts as a transformer and sits between TWIA and Alamo Re Ltd.. However, the Series 2015-1 Notes are not exposed to any further catastrophe events during this extension (only further claim development of existing events). The notes may be redeemed before the expected maturity date in response to specific early redemption events. The repayment of the Notes to the noteholders occurs subsequent to any qualified payments to TWIA for covered events. Noteholders have no recourse to TWIA (or to its transformer reinsurer, Hannover Ruck SE).

Alamo Re Ltd. ultimately ‘follows the fortunes’ of TWIA in regards to underwriting of new business and claim management practices over the respective three and four year risk periods for the 2015-1 Class A and Class B Notes. TWIA was established by the Texas Legislature in 1971 as a residual insurer of last resort. Although applicants must have been denied coverage by at least one commercial insurer, all properties insured by TWIA must be certified as built to specified building codes, must have flood insurance coverage in specified flood areas and have maximum limits per residential dwelling of $1,773,000 (higher limits are available for commercial structures).

KEY RATING DRIVERS

The rating is based on the evaluation of the natural catastrophe risk, the business profile of TWIA, the counterparty risk of the transformer reinsurer (Hannover Ruck SE) and the credit risk of the collateral assets. The natural catastrophe risk represents the weakest link and currently drives the ratings of the Series 2015-1 Notes.

The rating analysis in support of the evaluation of the natural catastrophe risk is highly model-driven. As with any model of complex physical systems, particularly those with low frequencies of occurrence and potentially high severity outcomes, the actual losses from catastrophic events may differ from the results of simulation analyses. Fitch is neutral to any of the major catastrophe modeling firms that is selected by the issuer to provide the modeling analysis, and thus Fitch did not include any explicit margins or qualitative haircuts to the probability of loss metric provided by the modeling firm.

The initial modeled annual attachment probabilities for the Series 2015-1 Class A and Class B Notes were initially estimated at 2.74% and 1.61%, respectively, based on 10,000 simulations of a one-year risk period as calculated by AIR using their methodology and proprietary models (Version 16.0 of the AIR Hurricane Model for the United States as implemented in Touchstone 2.0.2 and CATRADER 16.0). Results from other possible modelers or from TWIA were not provided. Sensitivity analysis provided by AIR indicated the implied ratings would be no worse than ‘B+sf’ for Series 2015-1 Class A and ‘BB-sf’ for Series 2015-1 Class B.

The risk modeling included certain stresses for economic demand surge, storm surge and an initial loss adjustment expense factor of 1.10. The modeled results did not include the possibility that the average annual loss may increase by up to 1.10 in any annual risk period. The AIR model does not model the probability of losses resulting from tropical storms that at no point are classified as a hurricane, hurricanes that degrade to tropical storm force and subsequently make landfall in the U.S. as a tropical storm, as well as storms that never make landfall in the U.S. that fail to cause winds of greater than or equal to 74 mph over any point in the U.S. Thus, the model understates claim losses to named storms not recognized as hurricanes or hurricanes that become degraded. Noteholders are exposed to this basis risk or the difference between actual net losses incurred by TWIA and the AIR modeled net losses.

Fitch did not rate TWIA in connection with the note issuance but believes certain other safeguards are in place for noteholders: TWIA is subject to review, oversight and approval by the Texas Department of Insurance (though it receives no federal, state or local funds for support); there is an independent claim reviewer and loss reserve specialist (Deloitte Ltd.) for Alamo Re Ltd. Series 2015-1 Notes; and the data quality of the subject business provided to AIR appears adequate.

Hannover Ruck SE (IDR ‘AA-‘; Outlook Stable) acts as the transformer reinsurer for TWIA and Alamo Re Ltd.. Noteholders are exposed to the risk that Hannover Ruck SE does not pass along retrocession premiums to Alamo Re Ltd. These premiums are a key component in the coupon payment to noteholders.

Proceeds from the issuance of each Class within the Series 2015-1 Notes will be held in a collateral account and used to purchase high-credit-quality money market funds meeting defined eligibility criteria; otherwise funds will be held in cash. Investment yields generated from these permitted investments are passed directly to noteholders of the applicable Class of Series 2015-1 Notes as the other component of the interest payment. Noteholders are exposed to possible market value risk if the net asset value of a money market fund falls below $1.00. Finally, certain actions may be required if the collateral account is invested in money market funds and Foreign Account Tax Compliance Act (FATCA) is deemed to apply in late 2016.

RATING SENSITIVITIES

This rating is sensitive to the occurrence of a qualifying event(s), TWIA’s election to reset the applicable Class within the Series 2015-1 Notes’ attachment levels, changes in the data quality or purpose of TWIA, the counterparty rating of Hannover Ruck SE and the rating on the assets held in the respective collateral account.

If qualifying covered events occur that causes annual aggregate losses to exceed either the Series 2015-1 Class A or Class B attachment levels, Fitch will downgrade the applicable Class of Notes reflecting an effective default and issue a Recovery Rating.

In the case of a reset election by TWIA, the rating of the Series 2015-1 Class A and Class B Notes, movement from the respective initial attachment probabilities closer to an attachment probability of 4.00% could lead to downgrades of the applicable Class(es) to as low as ‘Bsf’. Conversely, if TWIA elected to move the Series 2015-1 Class B attachment probability closer to 1.00%, the rating on the Notes would be unaffected, while a reset of the Series 2015-1 Class A attachment probability to as low as 1.00% could result in an upgrade to as high as ‘BB-sf’.

To a lesser extent, the Series 2015-1 Notes may be downgraded if the money market funds should ‘break the buck’, Hannover Ruck SE fails to make timely retrocession premium payments or TWIA materially changes its mission or operations.

The AIR escrow models may not reflect future methodology enhancements by AIR which may have an adverse or beneficial effect on the implied rating of the notes were such future methodology considered.