Combine Re catastrophe bond gets provisional ratings from Moody’s

Ratings agency Moody’s has issued a press release regarding the provisional ratings they have assigned to the Combine Re Ltd. catastrophe bond which is currently being marketed to investors. Combine Re Ltd., which we wrote about when it launched here, is a two tranche cat bond being sponsored by Swiss Re America on behalf of two actual beneficiaries who have reinsurance contracts with the Swiss reinsurers U.S. arm.

It’s quite unusual these days for Moody’s to rate a cat bond, Standard & Poor’s have been the rating agency of choice on most transactions over the last few years. Interestingly, the $100m Class A Series 2012-1 tranche of notes that are being issued by Combine Re have achieved a provisional rating of ‘Baa1’ which is considered an investment grade rating. This is a very rare occurrence in the cat bond and insurance-linked securities market, other deals that achieved an investment grade rating include Merna Reinsurance Ltd. and Gamut Re Ltd. from 2007, and will help to make that tranche of notes particularly attractive to a broad range of investors. The $50m Class B tranche has a provisional rating of ‘Ba3’ which is more typical of a cat bond transaction. We’re not sure whether the decision to approach Moody’s for a rating for this deal could have been due to the possibility of achieving this investment grade rating.

The Class A tranche, being investment grade notes, should be looked on more favourably by a much broader range of investors (some investors won’t touch anything that isn’t investment grade) so it will be interesting to see if this tranche increases in size from any heightened demand. The deal is actually $200m in size but a Class C tranche of notes does not seem to have been put forward for rating, often the case in Swiss Re sponsored cat bonds.

Moody’s note in their press release on the ratings that they base their ratings primarily on the expected loss that each tranche poses to noteholders. The Class A notes, which received the investment grade rating, have a one year expected loss of 0.01%, an attachment probability of 0.04% and an exhaustion probability of 0.00%. That is so low as to be almost no risk to investors in this tranche, and we’re not sure we’ve ever seen a tranche of notes with such a low expected loss. So that explains the investment grade rating. Sources tell us that for an event to trigger the Class A notes it would have to have a return-period in the hundreds of years, possibly even thousands. The Class A notes will also pay a low interest coupon, around 4%-5%, but that should still be sufficient to attract investors due to the low yields in other bond and financial markets at this time. This method of creating a tranche of cat bond notes which have an extremely low probability of attachment but can still pay a better interest coupon than investment assets which are more correlated to the financial markets could be a way to get significant sums of capital attracted to the ILS space. It’s a very interesting move from Swiss Re and could become a feature of other cat bond deals if successful. Interestingly the Class C tranche is expected to pay a coupon of over 17% so this deal offers investors both low-risk, low-coupon security as well as high-risk high-yield opportunities as well.

Moody’s provide much more detail on the transaction structure, some of which we summarise below:

Combine Re Ltd. is a Cayman Islands domiciled exempted company sponsored by Swiss Re America to issue cat bond deals. Swiss Re America is providing reinsurance for two companies, COUNTRY Mutual Insurance Company and North Carolina Farm Bureau Mutual Insurance, Inc. The Issuer, Combine Re, will provide fully collateralized, three-year certain catastrophe aggregate excess of loss retrocessional protection to Swiss Re, and the Combine Re will sell catastrophe bond notes to fund that protection.

The Combine Re deal is structured as an indemnity cat bond, based on the ultimate net loss of the two insurers with whom Swiss Re have two separate reinsurance agreements. Swiss Re then have two separate retrocessional agreements with Combine Re and the risks are ceded to noteholders.

Proceeds from the sale of the notes will be deposited in equal amounts in two separate collateral trust accounts and the proceeds invested in Treasuries or other highly rates assets.

The ceded risks are the two insurers ultimate net losses from the U.S. perils of hurricanes, earthquakes, severe thunderstorms and winter storms.

We’ll update you as Combine Re Ltd. comes to market. It’s going to be interesting to see whether it upsizes and whether investors are really interested in this deal at a time when a lot of higher coupon paying cat bond tranches are in the market. We suspect that interest will be high due to the investment grade rating.