Swiss Re Insurance-Linked Fund Management

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Loss faced by Ballantyne Re life securitization investors becomes clearer


Scottish Re’s 2006 Ballantyne Re life insurance securitization transaction has been heading for what seems like an inevitable default for some time now. The Regulation XXX type life insurance linked transaction saw huge mark-to-market losses on the assets in the underlying collateral accounts. As a result it experienced regular failures to make interest payments resulting in downgrades from ratings agencies and an understanding that default was almost a sure thing.

The problem lies in the selection of assets in the collateral account of Ballantyne Re. The proceeds of the sale of the notes were invested in subprime residential mortgage-backed securities and some other asset backed securities. Many of these collateral assets unsurprisingly lost significant value during the 2007/8 financial crisis which meant that interest payments are were near impossible to make. Scottish Re had themselves taken to making up missing interest on the payments for some time to attempt to meet obligations to the deals investors.

It became apparent almost a year ago that Ballantyne Re would end up defaulting to some degree, and now thanks to an update from Fitch Ratings we are a little clearer on just how bad this could be for the deals investors.

Fitch have published a report in which they affirm the ratings on the three affected tranches of notes and provide recovery estimates, for how much of the principal they feel is likely to be repaid to investors. It doesn’t make for good reading from an investors point of view. Fitch says that Ballantyne Re’s liabilities exceed the current book value of its collateral assets by a significant margin.

Fitch notes that interest payments on the $250m Class A-1 notes of Ballantyne Re remain current, and it expects them to for the foreseeable future. That will please investors that interest payments will likely be made. However they believe that without a remarkable recovery in the RMBS and ABS asset values it is probable that Ballantyne Re will at some point in the future become unable to pay interest or return the full principal on the class A-1 notes. Based on current market values of the collateral assets, Fitch says that it expects a principal recovery of 35% on the class A notes. So investors will only recover 35% of the principal outstanding at maturity and that could actually worsen depending on any further mark-to-market losses in the collateral accounts.

On the other two affected tranches of notes, Fitch says that they believe default is inevitable. The $10m class B-1 and $40m class B-2 notes will be a total loss and Fitch does not expect noteholders to receive any further interest or principal payments.

The Ballantyne Re XXX securitization was an interesting beast, coming in at around $2.1 billion in total with other tranches of notes which were not rated. Fitch estimates that in order for the class A-1 notes to fully recover principal the value of the collateral assets would need to appreciate by $1 billion, and for the class B note holders to recover their principal as well by another $100m on top of that. Very unlikely.

The notes could get downgraded further if the asset values decline further or if the underlying life insurance portfolios experience losses above expectations.

Given the situation with this deal it seems possible that a total default of the class A-1 notes could become a reality in the future. We’ll update you if we hear anything further about this deal.

Here’s an interesting aside for you. Ajax Re, a 2007 $100m earthquake catastrophe bond sponsored by Aspen Insurance actually invested part of its collateral in Ballantyne Re. Ajax Re was one of the cat bonds hurt by the failure of Lehman Brothers. This practice, of one insurance-linked security investing in another as part of its collateral, is thankfully not a feature of the market anymore (as far as we are aware anyway).We’re certain that regulators would not be happy with the practice from a systemic risk point of view.

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