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S&P put Residential Re 2011 & 2012 aggregate notes on watch due to Sandy


As expected, rating agency Standard & Poor’s have placed two aggregate tranches of catastrophe bond notes from USAA’s Residential Reinsurance 2011 Ltd. (Series 2011-1) and Residential Reinsurance 2012 Ltd. (Series 2012-1) transactions on CreditWatch with negative implications. We suggested this was likely to happen in this article last Friday, we also followed up on the fate or otherwise of the various Residential Re cat bonds in another article yesterday.

The two tranches of notes which have been placed on CreditWatch are the Class 5 notes issued under each deal, both of which accumulate losses on an annual aggregate basis. Both of these tranches of notes have been affected by qualifying loss events already during the current risk period and as such their attachment point has been effectively eroded. Now, hurricane Sandy looks like it will also cause the attachment point to be eroded even further after USAA issued an estimate of their ultimate net losses range from $129m to $363m, with a point estimate of $291m.

S&P said that they have placed the two Class 5 tranches of notes on CreditWatch due to the loss estimate notice related to Catastrophe Series 90 (the PCS number for hurricane Sandy). There have already been two other covered events for the current risk period, Catastrophe Series 77 (a central and northeast U.S. wind and hail tornado on June 6) and Catastrophe Series 83 (a central and northeast U.S. wind and hail tornado on June 28) that have generated estimated ultimate net losses of $187m. These two losses resulted in a downgrade for the notes in July. There was a third event which was thought to have qualified, Catastrophe Series 78, but that had its loss estimate reduced and at that time in October the notes had been upgraded again.

Now hurricane Sandy’s potential losses have put the two tranches of notes back on watch once again. S&P says that the addition of losses from hurricane Sandy decreases the amount of future losses necessary to trigger a loss to the notes investors and, in their view, increases the risk associated with these bonds.

S&P are asking the reset and calculation agent AIR Worldwide, to recalculate the probability of attachment for the remaining risk period, using these loss estimates. Once S&P receives those results, they will update the status of the CreditWatch, which they hope to do within 10 days.

S&P said that they don’t expect to need to lower the ratings on these notes by more than one notch once the probability of attachment has been recalculated, and note that there is a chance that the rating may not need reducing at all (if the estimates turn out to be over-estimates we assume). Once a rating decision is taken the notes will get removed from CreditWatch.

The current risk period runs until 31st May 2013, so there is some time left for these transactions to potentially accumulate further losses and get even closer to an attachment. These cat bonds cover a range of perils, hurricane, earthquake, severe thunderstorm, winter storm, and wildfire, some of which will be at their most prevalent during the remainder of the risk period so are by no means safe from loss. However it is worth reflecting on the fact that the attachment points for the two cat bonds are $1.365 billion for the Residential Re 2011 Class 5 notes and $1.571 billion for the Residential Re 2012 Class 5 notes, so there is still some way to go before the investors in these notes face any losses. It’s also worth noting that there is an unrated Class 7 tranche of Residential Re 2012 notes which are aggregate and attach at $900m, so those will also have qualifying losses and be more risky.

We’ll update you when more information becomes available.

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