Investment bank Credit Suisse’s Operational Re Ltd. transaction, which uses a catastrophe bond structure to secure insurance via the capital markets for operational risk exposures, has now been successfully settled at a size of CHF 220m (around $223m).
A number of factors changed as the deal made its final progress to market, with investors requirements resulting in the issuance of a third tranche of notes and the risk retention held by insurer Zurich reducing down to just CHF50m, Artemis understands.
Artemis has now seen the final terms and pricing agreed for the Operational Re transaction, which show that Credit Suisse increased the size of the deal slightly from the CHF200m it had shrunk to ten days ago, to complete it at CHF220m.
So, as we understand it from the details seen, the investment bank now has in place a CHF270m operational risk insurance policy from insurer Zurich, effective today, with Operational Re providing CHF220m of the capital via a reinsurance arrangement between itself and the insurer, collateralised by the sale of the three tranches of notes to investors.
The insurance arrangement underlying the Operational Re notes runs from today for just over five years, to the end of May 2021, Artemis understands, providing Credit Suisse with a mostly collateralised source of operational risk cover for the duration of this term.
Credit Suisse continues to retain CHF3.5 billion of operational risk losses before the insurance would kick in (so the attachment point) and we understand that it still cannot be triggered by a single operational risk event, with the coverage on an annual aggregate basis.
Before close, the transaction changed slightly, in terms of the number of tranches of notes issued by Bermuda domiciled special purpose insurer Operational Re Ltd.
We understand that a CHF105m Class A-1 tranche, a CHF5m Class A-2 tranche both pay investors a 4.5% coupon, with the A-2 tranche a Reg S issuance in larger denomination notes, so likely to meet a specific investors needs. Meanwhile the riskier junior tranche remained a CHF110m Class B set of notes that was also issued, and will pay investors a 5.5% coupon.
So it looks like the operational risk insurance coverage that Credit Suisse will receive through the transaction will be just over 80% provided by the reinsurance sourced through the capital markets and this insurance-linked securities (ILS) transaction, with investors in Operational Re on the hook for CHF220m of qualifying losses while Zurich retains CHF50m of the risk.
We understand that some ILS fund managers have participated in the transaction, finding the notes a diversifying risk for portfolios often over-weighted towards natural catastrophe risks. But at the same time the majority of the ILS market has not invested in the notes, with many of the managers we’ve spoken to about the deal saying that the risk is hard if not impossible to truly quantify.
So the deal has now completed successfully for Credit Suisse and in this unique transaction the investment bank has secured a new source of risk capital to cover losses due to operational risks.
The transaction does signal a willingness of the ILS market to step outside if its known and well-modelled boundaries and look at new, corporate type risks. It also signals that there are investors out there not already participating in catastrophe bond and ILS fund investments for whom a risk based asset linked to the performance of a major bank is a palatable allocation to make.
That also suggests that the ILS market will continue to grow and expand its remit, as capital markets financing and the securitisation structure of the cat bond will in future be applied to a widening range of corporate and other risks.
While the initial targeted size of CHF630m proved too much of a stretch for the capital markets to support, Credit Suisse will now benefit from a new source of operational risk insurance that the traditional insurance and reinsurance market may not have been able (or perhaps willing) to provide in its own.
Also read much more detail on this transaction in our previous coverage: