A. M. Best now puts Lehman Brothers linked cat bonds on credit watch. The bonds in question are:
WILLOW RE Ltd
Ajax Re Ltd
Carillon Re Ltd
Newton Re Ltd.
As the guarantor of the swap counterparty has become bankrupt that technically means the swap agreements are terminated.
Willow weep for me, bend your branches down along the ground and COVER me.
Of course this all begs the question, who is covering Allstate’s Hurricane exposure? Was today’s commentary by AM Best on Allstate’s financial strength a bit premature? Perhaps leave out something? The good folks at Bloomberg tell the what and it is HUGE:
A catastrophe bond sold by Allstate Corp. faces “imminent” default following the collapse of Lehman Brothers Holdings Inc., Standard & Poor’s said. It would be only the second such security to fail in a decade.
New York-based S&P downgraded $250 million of debt sold by Allstate’s Willow Re Ltd. to D, the lowest grade, from CC, according to a Jan. 30 statement. Northbrook, Illinois-based Allstate set up Willow Re as a means of selling the bonds in 2007 to protect against claims from hurricanes, and investment losses by Willow Re aren’t tied to Allstate’s own portfolio.
“The issuer has notified Standard & Poor’s that it will not have sufficient funds to make the scheduled interest payment,” S&P analyst Gary Martucci in New York wrote in the statement.So-called cat bonds have gained popularity as a way for insurers to protect against natural disasters, and buyers demand outsized returns because they risk losing their entire investment to the insurer if the catastrophe is large enough. With Willow Re and other bonds backed by Lehman, investors are on the verge of losing a portion of their stake because of a financial calamity instead of a natural one.
“The market was already pricing Willow Re in the area of 50 cents,” said Christophe Fritsch, head of insurance-linked securities at Axa SA in Paris. “New deals will improve dramatically. Investors will make sure that they will only be exposed to insurance risk and won’t take credit risk.”
Willow Re is one of four catastrophe bonds that used contracts sold by Lehman to guarantee returns on collateral backing the notes and to make interest payments. Lehman’s collapse in September nullified the guarantees, leaving the securities open to market value losses on the collateral.
“Since Lehman’s bankruptcy terminated the total-return agreement, a portion of the interest and principle due to noteholders is subject to market risk,” said Maryellen Thielen, a spokeswoman for Allstate. “The default of Willow Re does not create any contractual obligations for Allstate.”
Thielen said Willow Re intends to pay about 95 cents on the dollar for its scheduled February payment. The bonds, due to make an interest payment today, have a five-day grace period until a default is declared, the S&P statement said.
The defaulted bond accounts for less than 5 percent of Allstate’s overall reinsurance program, Thielen said.
S&P grades the other three cat bonds that used Lehman as a swap counterparty at either CC or CCC, its third and fifth- lowest ratings.
Bond investors in Zurich Financial Services AG’s Kamp Re 2005 Ltd. were the first to lose money when property damages caused by Hurricane Katrina in 2005 exceeded the threshold that entitled Zurich to keep investor funds to pay insurance claims.
Scor SE, France’s biggest reinsurer, is seeking to sell $200 million of catastrophe bonds to transfer potential losses on U.S. earthquakes, S&P said last week.
“Despite some drawbacks on a very small number of transactions, the outlook for 2009 is very good as the market expects to see a number of new transactions that will offer higher yields to reflect the current market environment,” said Michael Stahel, head of insurance-linked investments at Clariden Leu in Zurich.
Ms Thielen is subtly deceptive in her remarks that, “The default of Willow Re does not create any contractual obligations for Allstate.” As our good friend Mr CLS would point out this does have an impact on Allstate. When a company buys reinsurance it is transferring some of its risk risk to a third party and in turn gets to take a credit towards statutory capital reserves for the amount of the risk transferred. If the bonds default it will impact Allstate in several areas including it’s reinsurance program and it’s rate up calculations with the various State DOI’s (Departments of Insurance). Other commentators such as gold guru Jim Sinclair are more pessimistic and for good reason given the implosion of our financial system:
All our insurance companies are broke. Thank you one more time to the OTC derivative manufacturers and distributors.
We’ll be following this story as it develops. Meanwhile Willow RE’s bagholders, I mean bondholders, gently weep.