Swiss Re Insurance-Linked Fund Management

Xactanalysis Insights and PCS

Queen Street II Capital cat bond collateral also affected by debt ceiling


Another of reinsurer Munich Re’s catastrophe bond transactions has been adversely affected by the uncertainty over the U.S. debt ceiling. Queen Street II Capital Ltd. has suffered a loss of principal in the collateral account due to a decline in its per-unit mark-to-market value.

The Queen Street II Capital catastrophe bond provides Munich Re with $100m of retrocessional reinsurance protection on a per-occurrence basis against North Atlantic U.S. hurricane and European windstorms until March 2014. The deal was issued in March 2011.

The reason for this loss of value of the cat bonds collateral is exactly the same as suffered by the Queen Street III cat bond, which we wrote about on Wednesday here.

The collateral assets for the Queen Street II Capital cat bond were invested in a dedicated investment fund, the MEAG Queen Street II fund, managed by the asset management arm of Munich Re, MEAG MUNICH ERGO Kapitalanlagegesellschaft mbH. This fund has strict investment guidelines which do not allow the per-unit value of the fund to fall below $100.00.

Due to the uncertainty created by the U.S. debt ceiling issue, the per-unit value of this fund declined and as a result the indenture trustee of the fund, the Bank of New York Mellon, liquidated the fund meaning that the loss of value was realised as a loss of principal.

The loss of principal from the liquidation of the MEAG Queen Street II fund faced by Queen Street II investors amounts to $20,242.13, or 2 basis points. The cash proceeds from the liquidation, $99,979,757.87, have been reinvested into U.S. Treasury Cash reserves.

As a result of the loss of principal, ratings agency Standard & Poor’s has placed its ‘BB- (sf)’ rating on the notes issued by Queen Street II Capital on CreditWatch negative because in its view the loss of principal reduces the chance that investors will receive their full principal back on maturity of the cat bond.

S&P said that the CreditWatch placement reflects a one-in-two chance of a downgrade to ‘CC (sf)’ in the next three months if it considers there is a high probability that the holders of the notes will not receive 100% of the $100m of principal originally deposited in MEAG Queen Street II.

As with the Queen Street III cat bond, S&P will watch how the collateral deficit is dealt with over the next three months before deciding how to resolve the CreditWatch, either with a downgrade if the loss of principal remains or removing the watch if the collateral assets recover to 100%.

As we said on Wednesday, this is a great example of how vagaries in the financial markets can impact on catastrophe bonds, again showing that nothing is completely uncorrelated. Cat bonds are extremely low correlating assets but there can always be a knock-on effect from an issue like the debt ceiling, especially in complex financial transactions like securitizations.

There is a chance that Munich Re may elect to top up the collateral accounts for these bonds, given the loss is not that significant in size.

It looks like some of the more recent Queen Street catastrophe bonds, sponsored by Munich Re, also used MEAG funds. At this time we’re not sure whether they are likely to be impacted but if they are we’d expect S&P to report on them in the next few days.

We will keep you updated as the CreditWatch is resolved by S&P in the coming weeks on both the Queen Street II and Queen Street III catastrophe bonds.

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