Swiss Re Insurance-Linked Fund Management

PCS - Emerging Risks, New Opportunities

Vega Capital Ltd. 2010-1 Class C notes placed on review by Moody’s, potentially triggered


Rating agency Moody’s has placed the Class C catastrophe bond notes of Vega Capital Ltd. 2010-1 on review for possible downgrade due to the earthquake event in Japan on the 11th March. The $63.9m of cat bond notes issued by Vega Capital in December 2010 provide Swiss Re with cover against qualifying earthquakes in Japan as well as certain European windstorms, Japan typhoons, California earthquakes and North Atlantic hurricanes.

As a result of the severity of the event in Japan, Moody’s believes it’s likely that the trigger level for this transaction will be exceeded. Vega Capital 2010 is structured in such a way that if triggered by this event it won’t experience any immediate losses, however as a second and subsequent event deal, it will be exposed to losses should one more event pass its trigger levels in the first year of the deal. As a recently issued cat bond, this deal has to run until December 2013, so the potential for a default at some point during its lifetime would be significantly raised.

Moody’s states in their press release on this deal:

Moody’s expects that the Japan Earthquake, as an event covered under the terms of the transaction, will possibly breach the trigger level for such peril and erode the first loss protection available to the rated notes.

The cat bond uses a parametric trigger for Japanese earthquake risks based on data from the Japan Meteorological Agency. The risk modeller creates an index using JMA data against which events are measured to determine if they were severe enough to cause any losses and to measure the amount of losses experienced.

Vega Capital is structured so that it uses a reserve account to build up an extra layer of protection for investors. As the catastrophe bond was issued so recently, the reserve account hasn’t built up much meaning the other layers of the transaction remain more exposed. The Class C notes sit above a Class D tranche (that is unrated) in the transaction which has to be degraded first before losses occur. Moody’s comments on the outlook for this cat bond:

Because the loss trigger mechanism of the transaction limits the annual losses attributable to each separate peril, a second covered event (other than an earthquake in Japan) is required for the Class C Notes to experience losses. This is true even if the entire $37.5 million Japan aggregate annual limit is reached due to the Japan Earthquake, given the current $53.1 million available as a first loss layer benefitting the Class C Notes.

So, while this deal won’t experience a loss from this event, Moody’s feels that it is likely that the Japanese earthquake will qualify and as a result require a downgrade for the Class C notes as they will be much more exposed to future losses during the first year of its tenure.

Vega Capital becomes the fourth cat bond transaction to be put on negative watch for potential downgrade in the aftermath of the Japanese Tohoku earthquake event. The other deals impacted are: Topiary Capital, Vita Capital IV and Montana Re. The final outcome for all these deals, whether they will be triggered and as a result downgraded, should become clear in the coming days/weeks.

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