S&P remove Residential Re 2011 & 2012 cat bond notes from CreditWatch and affirm

Rating agency Standard & Poor’s have resolved the rating uncertainty on two aggregate tranches of catastrophe bond notes from USAA’s Residential Reinsurance 2011 Ltd. (Series 2011-1) and Residential Reinsurance 2012 Ltd. (Series 2012-1) transactions. Both tranches had been on CreditWatch since the 6th November due to the potential impact of hurricane Sandy on the cat bonds sponsor USAA. Now the loss estimates have been updated and S&P has resolved the CreditWatch for both tranches.

On the 6th November the Class 5 notes issued under each cat bond deal, both of which accumulate losses on an annual aggregate basis were placed on CreditWatch with negative implications due to potential exposure to Sandy. Both of these tranches of notes had been affected by qualifying loss events already during the current risk period and as such their attachment point had been effectively eroded before Sandy came along. USAA issued an estimate of their ultimate net losses range from $129m to $363m, with a point estimate of $291m, and on the basis that any additional aggregate losses make the notes more risky S&P put the notes on Watch.

Then on the 15th November S&P downgraded the Residential Reinsurance 2011 Ltd (Series 2011-1) Class 5 notes to ‘B+(sf)’ from ‘BB-(sf)’ as these have the lower attachment point of the two tranches and so are deemed most at risk. Both tranches were kept on CreditWatch negative as S&P waited for the hurricane Sandy loss development to continue.

Two events have already caused qualifying losses for the notes, Catastrophe Series 77 (a Colorado and Wyoming wind and hail tornado that occurred on the 6th of June) and Catastrophe Series 83 (a central and northeast U.S. wind and hail tornado that occurred on the 28th of June) which between them have generated estimated covered losses of $187 million. The estimate from hurricane Sandy added to this figure reduces the additional qualifying losses required for the attachment points to be breached, $1.365 billion for the Residential Re 2011 Class 5 notes and $1.571 billion for the Residential Re 2012 Class 5 notes.

In an announcement published today S&P said that USAA’s estimate of ultimate net losses from Sandy has been updated. In addition, the covered loss amount from Catastrophe Series 77 has increased and the loss estimate from Catastrophe Series 78 (a Texas wind and hail tornado that occurred on June 11) has been updated so that it now exceeds the franchise deductible amount and qualifies as an aggregate loss.

Despite the addition of a new qualifying event, in Catastrophe Series 78, the total estimate of covered losses that qualify for the note is still less than the figure S&P had on the 15th of November, if it had used the upper end of the original Sandy loss estimate. So that suggests that the Sandy loss USAA suffered came in low enough below the original upper point to allow for the losses of 78 to slot in as well without worsening the outlook for the cat bond notes.

The notes aren’t due to be reset until the 31st May meaning that they still have some way to run with an increased probability of attachment given that they require a reduced amount of additional losses to be triggered. However it will take some large catastrophe events to impair these notes so investors will likely be comfortable holding onto positions in them.

S&P did not change the ratings on the downgraded Series 2011-1 Class 5 notes, saying that the updated probabilities of attachment that reset and calculation agent AIR Worldwide has provided are in line with the current ratings. If the covered losses do not increase enough to reach the attachment point through the rest of the risk period S&P may upgrade the Series 2011 notes at that time. S&P today affirmed the ratings on both tranches of notes after removing them from CreditWatch negative status.

The cat bond investment market has been quite comfortable with these notes with any price decrease that Sandy caused soon recovered, showing that investors quickly understood the new level of risk the notes presented. In fact they currently both price above par showing that investors maintain enough confidence in the notes to continue to invest in them.

As the notes reset before the next U.S. hurricane season the main seasonal threat to them will be from severe thunderstorms and tornadoes through the Spring.