Swiss Re Insurance-Linked Fund Management

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Queen Street III cat bond principal repayment falls short, defaults


Munich Re’s Queen Street III Capital Ltd. catastrophe bond which matured last week saw a shortfall in the amount of principal repaid to investors, as the cat bonds exposure to last years U.S. debt ceiling financial issue shrank the capital returned to investors.

To refresh your memories, last October we wrote that the Queen Street III Capital cat bond was the first to be impacted by the financial market uncertainty surrounding the U.S. debt ceiling crisis. The MEAG Queen Street III fund, which held the cat bonds collateral assets, saw a decline in its per-unit mark-to-market value.

The Queen Street III catastrophe bond provided sponsor Munich Re with $150m of retrocessional protection against European windstorm risks, with a combined statistical return period of around 50 years, over a three-year term. The deal was issued in mid-2011.

The fund, designed to hold the collateral until the cat bond matured or a payout became necessary, faced strict asset value guidelines stating that the per-unit value may not fall below $100.00. Due to the uncertainty surrounding the U.S. debt ceiling the value of the treasury bill fund dropped enough that the indenture trustee was mandated to liquidate the MEAG Queen Street III fund and reinvest the collateral proceeds in Federated U.S. Treasury Cash Reserves.

Because of this the collateral assets lost some of their value and the full principal could not be repaid to the cat bonds investors at the redemption date of July 28th 2014.

According to rating agency Standard & Poor’s, the investors in the Queen Street III cat bond received back 99.98% of the outstanding principal on the notes. The cat bond was $150m in size meaning that the two basis points drop equates to a $28,374.65 shortfall on the proceeds due to investors.

S&P’s rating criteria for catastrophe bonds allows for a one basis point shortfall, which for the $150m cat bond would have allowed for $15,000. With the shortfall being greater than this minimum, S&P downgraded its issue rating on the notes to ‘D (sf)’ (default) from ‘CC (sf)’.

That technically puts the Queen Street III Capital Ltd. cat bond into default, despite the rating downgrade coming after the redemption date on which the principal that was available was repaid to investors. S&P said that it expects to withdraw its rating on the notes within the next thirty days.

The same debt-ceiling related issue and subsequent default also happened to the Queen Street II Capital Ltd. catastrophe bond, which saw a shortfall of two basis points at its redemption in April this year.

With such a small shortfall of principal it is likely that investors accepted these minor losses, although begrudgingly we would imagine. The case of Queen Street III Capital and other cat bonds affected by a loose link to the U.S. debt ceiling issue should be a reminder that very little is truly uncorrelated in this world and there is always a remote chance that unforeseen financial market circumstances can affect the success of any transaction.

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