Here’s a piece of news that you may not be expecting which has just broken and could hint at how the much discussed RMS risk model change may be reacted to by the ratings agencies. One tranche of USAA’s 2009 Residential Reinsurance 2009 Ltd. catastrophe bond has been downgraded due to an updated risk model, but it’s not the Risk Management Solutions model, rather in this case it is due to the upgrade of AIR Worldwide’s CLASIC/2 U.S. hurricane model.
Standard & Poor’s have downgraded the rating on Residential Reinsurance 2009 Ltd’s $75m Class 2009-1 notes from ‘BB-‘ to ‘B+’ in the last couple of hours due to changes in AIR Worldwide’s model. At issue the notes were modelled against the CLASIC/2 version 10.5 and this model was escrowed to be used for each annual reset for the life of the transaction. However AIR have released version 12.5 of their model and now S&P have compared the attachment point of the notes to the probability of attachment using the latest version of the model and found the new result warranted a one notch downgrade.
The notes have been reset using the terms of the original transaction, so utilising the older model version. However, S&P explains: “Our criteria say that if a modeling company issues an updated model and we believe there are significant changes in our perception of the risk for such peril, we may change the rating on any outstanding bonds, even if there is no model-based reset in the terms of any of the bonds concerned. Although the changes between Versions 10.5 and 12.5 were not as significant as other model updates have been, the changes were significant enough to cause a one-notch downgrade to these notes.”
This is unlikely to upset investors too much as should hurricanes occur the model which will be used for calculating whether an event qualifies under the terms of the cat bond will be the older version (we assume as it’s escrowed for the term of the deal). However it could be taken as a hint of actions to come to other catastrophe bond ratings once S&P have information back on the impact to attachment points and expected losses of the new RMS model to cat bonds which utilise it. It’s also worth noting that Residential Re 2009 is one of the cat bonds potentially at risk from recent severe thunderstorm and tornado aggregate losses and it’s unknown at this stage how that will affect the deal (if at all).