Residential Reinsurance 2013 Ltd. (Series 2013-2)

This is USAA’s twenty-first catastrophe bond under the Residential Re banner.

This latest Residential Re cat bond sees USAA seeking a multi-peril source of fully-collateralized reinsurance protection, using an indemnity trigger and on a per-occurrence basis over a four-year period, via the issuance and sale to investors of two tranches of Series 2013-2 notes through Cayman Islands based Residential Reinsurance 2013 Limited.

The first tranche of notes, which we understand to be Class 1, will cover U.S. tropical storms but excluding the state of Florida, U.S. earthquakes, severe thunderstorms, winter storms and wildfires in California. This tranche is being marketed with a preliminary size of $50m.

The second tranche, which we’re told is Class 4, covers U.S. tropical storms including the state of Florida, U.S. earthquakes, severe thunderstorms, winter storms and wildfires in California. This tranche has a preliminary size of $70m, we understand.

Now the interesting aspect of the deal, the levels of risk and reward in the two classes of notes offered.

Class 1 is the riskier of the two and we’re told has a probability of attachment of 21.38%, an expected loss of 13.06% and is being marketed with a coupon guidance range of 21% to 22%. We’re struggling to think of a cat bond tranche in our Deal Directory with a higher attachment probability and coupon than that.

The Class 4 tranche is much less risky, with an attachment probability of 2.26%, an expected loss of 1.61% and offering a coupon in the range of 5.75% to 6.5%. This is much more typical of an average yielding cat bond tranche.

We understand that the Class 1 notes attach at $400m of losses to USAA and will pay losses on a sliding scale, depending on the size the tranche actually completes at, up to an exhaustion point of $800m. Class 4 notes meanwhile attach at $2.076 billion of losses and again cover losses on a pro-rata basis up to the exhaustion point of $2.993 billion.

The Residential Re 2013-2 cat bond covers personal-lines losses only, including from homeowners, condominiums, rental and dwelling insurance policies. The coverage will benefit USAA itself, as well as affiliates including; USAA Casualty Insurance Co., USAA Texas Lloyd’s Co., USAA General Indemnity Co., Garrison Property and Casualty Insurance Co.

USAA will itself retain at least a 10% share of the losses in the attachment layer of the Class 4 notes, according to S&P’s pre-sale report. It’s likely that the same share will be retained in the Class 1 layer as well, which is typical of cat bond deals.

The cat bond will provide USAA and affiliates with protection over a four-year term, but across five risk-periods. The reason for this is that the first risk period is slated to begin in December 2013 but the annual resets are to occur on June 1st, ready for the hurricane season, meaning that there are risk periods of roughly six months and three of a year.

The transaction covers:

• Losses from hurricanes in; Alabama, Arkansas, Connecticut, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Mississippi, Missouri, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Vermont, Virginia, West Virginia, and the District of Columbia.
• Losses from earthquakes in all 50 states and the District of Columbia. However, it will not cover losses arising out of property damage caused by fire following in Hawaii or Alaska.
• Losses from severe thunderstorms and winter storms in the 48 contiguous states and the District of Columbia.
• Losses from wildfire in California.

Based on risk analysis from AIR Worldwide, no historic hurricane or earthquake generated net losses that would have resulted in losses for note holders for the Class 4 notes. The next three historical events that generated the highest modeled losses for the Class 4 tranche were the 1906 San Francisco earthquake ($1.972 billion), the 1812 New Madrid earthquake ($1.828 billion), and the NoName4 Hurricane that made landfall in 1938 in New York ($1.625 billion).

Given the low attachment point of the unrated Class 1 tranche of notes Artemis understands that historical modelling showed that a number of events would have caused a loss to noteholders. For example, Artemis is told that the NoName4 Hurricane that made landfall in 1938 in New York would have caused a 100% loss of principal to the Class 1 notes, as would hurricane Hazel which struck South Carolina in 1954 and hurricane Katrina which struck New Orleans in 2005. A number of other historical hurricane events would have caused some loss of principal to these notes.

Three historical earthquake events would have caused a 100% loss of principal to the Class 1 notes, Artemis understands. The 1906 San Francisco earthquake, 1812 New Madrid quake and the 1886 Charleston earthquake. No other modelled historical earthquake events would have breached the trigger.

According to S&P, at the current $70m size the Class 4 notes would provide cover for 7.63% of losses between the attachment point of $2.076 billion and the exhaustion point of $2.993 billion. That percentage will change if the tranche of notes increases in size.

The $50m of Class 4 notes, which attach at $400m of losses to USAA will cover 12.5% of losses (at the current tranche size, up to the exhaustion point of $800m. Again that percentage could change depending on the investor appetite for the riskier tranche of notes.

Residential Reinsurance 2013 Ltd. is a Cayman Islands domiciled special purpose vehicle and is being administered by Kane (Cayman) Ltd.

The proceeds from the sale of the notes will be deposited in a trust account and invested in U.S. Treasury money market funds.

Update:

The multi-peril cat bond transaction as a whole has increased in size by 25%, from $120m to a currently marketed size of $150m. The deal has not yet closed to investor subscriptions, Artemis understands, so there is a chance that it could grow a little further.

Interestingly, the tranche which has upsized is the riskier Class 1 tranche, which has a probability of attachment of 21.38%, an expected loss of 13.06% and was marketed with pricing guidance of 21% to 22%. This Class 1 tranche is now $80m in size, up by 60% from the $50m it was marketed at, showing that investors are happy to take this, perhaps most risky cat bond tranche issued, layer of catastrophe risk right at the bottom of USAA’s reinsurance tower.

The Class 1 tranche price guidance has also reduced, down to 20% to 21%, showing that investors are also willing to price this riskier layer at a level which likely makes it extremely attractive to USAA.

Meanwhile, the Class 4 tranche of notes, which is less risky with an attachment probability of 2.26%, an expected loss of 1.61% and launching with a pricing range of 5.75% to 6.5%, has remained the same size at $70m. Pricing expectation has however dropped to 5.25% to 5.75%, again showing ILS investors demand for new risk.

Update 2:

Both of the tranches issued saw their price guidance lowered as the deal came to market. In the end both tranches were priced at the lowest end of the already reduced range, showing continued strong appetite for cat bond risk, even at the riskier attachment level.

The Class 1 tranche was marketed with pricing guidance of 21% to 22%, which was subsequently lowered to 20% to 21%. Final pricing for this risky tranche was at 20%, which is almost a 7% drop in pricing from the mid-point of the originally marketed range.

The Class 4 tranche of notes launched with a pricing range of 5.75% to 6.5%, which subsequently was lowered to 5.25% to 5.75%. This tranche priced at the lowest end again, at 5.25%, a 14% decline in pricing from the originally marketed mid-point.

Update, November 29th 2017:

We understand that USAA has elected to repay half of the Class 1 notes $80 million of principal at maturity, but to extend the remaining $40 million as its loss estimates develop for the recent California wildfires.

By extending maturity on half of the tranche, so $40 million of principal, USAA is making sure there is some collateral remaining on account to pay for any losses should its estimate for the impact of the California wildfires surpass the notes attachment point (which had been $400m at launch of the cat bond tranche).

The latest loss estimate from USAA suggested that its California wildfire losses would be between $387 million and $581 million, so there is a reasonable chance that the final loss determination could have caused some loss of principal for these notes, eating into the reinsurance coverage they provide with the Class 1 notes being most at risk.

Update, February 28th 2018:

The maturity date for the remaining $40 million of principal from the Class 1 notes has been extended again to June 6th 2018, to allow for loss development from the California wildfires to continue.

Update, August 29th 2018:

Half of the $40 million of remaining Class 1notes have been allowed to mature and are to be repaid to investors, leaving another $20 million remaining which have now had their maturity extended again to December 6th 2018.

Update Dec 5th, 2018:

The remaining $20 million of notes from this tranche have now been extended further to March 6th 2019, to allow for further development of losses. These notes are priced for a roughly 65% loss of principal in the secondary market.