Queen Street II Capital Ltd.

Munich Re has issued a new catastrophe bond under an Irish special purpose vehicle, Queen Street II Capital Ltd. This is Munich Re’s second Queen Street cat bond transaction.

Queen Street II Capital Ltd. will provide Munich Re with three years of protection on a per-occurrence basis against North Atlantic U.S. hurricane and European windstorms until March 2014.

As well as being the counterparty in this risk transfer Munich Re are also arranging the deal themselves.

The transaction provides Munich Re with cover against U.S. hurricanes in certain states (including the usual east and gulf coast states) and uses an industry loss index from PCS for measurement on that portion of the deals risk. The cover for European windstorms will be active for losses in Belgium, Denmark, France, Germany, Ireland, Luxembourg, the Netherlands, and the U.K. and will utilise the PERILS AG industry loss data. When losses exceed a predefined attachment point on the indices the cat bond would be triggered.

AIR Worldwide are providing risk modelling for the Queen Street II cat bond using their U.S. hurricane model and European windstorm models. For European windstorms AIR will be augmenting their own industry exposure database with data from the PERILS industry exposure data. An annual reset of payout factors and exposure data will be undertaken which could result in changes to the attachment probability and expected loss after each reset.

Proceeds from the sale of the notes by Queen Street II Capital Ltd. will be invested in a U.S. Treasury money market fund set up specifically for this transaction. A Munich Re subsidiary MEAG MUNICH ERGO Kapitalanlagegesellschaft mbH, will manage the MEAG Queen Street II fund, and is seeking a triple-A rating for it.

The notes priced towards the high end of guidance at 7.5% above U.S. money market funds.

The notes have an expected loss of 1.59% overall, 1.09% for U.S. hurricanes and 0.5% for European windstorms.

Update February 2014:

Queen Street II Capital Ltd. was both placed on CreditWatch in November 2013 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 bond matured or a payout was required, meaning that the fund faced strict asset value guidelines which stated that the per-unit value could 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.

For the Queen Street II cat bond the loss of principal from the liquidation of the MEAG Queen Street II fund faced by investors amounted to $20,242.13, or 2 basis points. The cash proceeds from the liquidation, $99,979,757.87, were reinvested into U.S. Treasury Cash reserves.

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 transaction face a heightened risk that they will not receive back 100% of the outstanding principal amount on the redemption date.

As a result S&P has downgraded the rating on the $100 million principal-at-risk variable-rate notes issued by Queen Street II Capital Ltd. to ‘CC (sf)’ from ‘BB- (sf)’. The cat bond notes 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 about both of the cat bonds; “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 II Capital Ltd. cat bond S&P said it expects a shortfall of $20,242.13 on the proceeds returned to investors at the redemption date and that it expects to lower the rating to ‘D (sf)’ (default) from ‘CC (sf)’ on April 9th 2014, when it anticipates investors will get back $99,979,757 of the original $100m of principal.