I’ve been sent several articles on the Cat Bond market of late, some very good and some not necessarily worthy of the publication in which they were printed. I’ll start with an article from The Banker Magazine which is not yet online which I read courtesy of Factiva. While the article is generally good the author, Edward Russell-Walling parrots some long discredited facts about Cat Bonds, such as their being non correlated with the broader financial markets which the financial crisis of last year exposed as pure BS and it is there we start:
In 2008, the annus horribilis, non-correlation did not prevent it slumping to $2.7bn. Some hedge funds, which had been prominent players in this market, became distressed sellers and depressed pricing. The situation was aggravated by the downgrade of four cat bonds exposed to Lehman Brothers which, as total return swap counterparty, was effectively holding the investors’ capital.
What the author neglects to mention was “the innovation” of stuffing issues full of subprime mortgages whose accompanying (illusory) high yields no doubt drastically lowered the cost to the issuer. Lehman, as the guarantor, is cited as a problem because of its insolvency but the fact is TARP and the United States taxpayers are what has propped up every such issue so structured as major guarantors like AIG and the other Wall Street investment banks were essentially insolvent meaning their financial guarantees were worthless. Without the Lehman guarantee for instance Allstate’s Willow Re, which defaulted on their interest payments to investors earlier this year, plunged to around 50 cents on the dollar or roughly about what the underlying subprime mortgages were worth.
That said Russell-Walling did give a good explanation of the concept of the “trigger” in these agreements and it is there we pick back up:
Special thanks to Chris Sposato. If memory serves there were a dirty (half) dozen “guaranteed” Cat Bond issues connected to Lehman. The second to come tumbling down belongs to Bermuda based Aspen Insurance Holdings, Ltd. and their special purpose entity Ajax Re Ltd. The associated ri$k to take a hit is covered earthquake damage in California. The story itself begs additional research as this deal sounds as if there might be Cat Bonds stuck inside Cat Bonds with a (subprime) Mortgage Backed Security twist. The list of players per the article is very convoluted as well. The Royal Gazette has the Bloomberg story:
Ajax Re Ltd., a catastrophe bond sold by Bermuda-based Aspen Insurance Holdings Ltd., is likely to default on an interest payment this month, Standard & Poor’s said, the second such security hurt by Lehman Brothers Holdings Inc.’s collapse.
S&P said it may downgrade $100 million of debt issued through Ajax Re Ltd. to D, the lowest grade, from CC, citing an “imminent interest payment default”, according to a statement from the New York-based ratings company yesterday.
Aspen sold the bonds in 2007 to protect against claims from Californian earthquakes.
S&P said it lowered its counterparty credit and financial strength ratings on 10 groups of U.S. life insurers, and its counterparty credit ratings on seven U.S. life insurance holding companies.
“In response to the extreme pressures in the global economy, we recently published criteria that outlined the incremental stress analysis we are now applying to U.S. insurers’ bond holdings, commercial mortgages, and commercial mortgage-backed securities when we assess these companies’ capital adequacy,” S&P said.
The ratings firm added that, “Although today’s rating actions reflect our opinion of a general decline in the overall creditworthiness of the U.S. life insurance sector, we continue to believe the credit fundamentals of the life insurance industry are strong.”
Insurers affected by the ratings changes include Conseco Inc., which saw its counterparty credit rating cut to CCC, denoting very weak security characteristics. Genworth Financial Inc. saw its rating cut to BBB, denoting good but more likely to be affected by adverse business conditions than higher-rated insurers, while Hartford Financial Services Group Inc.’s rating was cut to BBB+
The S&P report, which can be found here if you sign up for a free account has many salacious tidbits backing what I’ve been saying for several weeks now on a topic we’ve blogged about for months beginning with Senate Majority Leader Harry Reid’s welcome here last fall. Here are some excerpts:
This post begins with a bleg. Exactly how does State Farm derive $4 billion of reinsurance coverage from $1.1806 billion of actual notes outstanding? There are some very bright financial minds that are stumped by that question. So in this game of Slabbed emulates Jeopardy, let’s set up the question and bleg at the beginning when the deal included toxic paper (which I emphasize):
CHICAGO–(BUSINESS WIRE)–Fitch Ratings expects to assign the following ratings to the proposed notes of Merna Reinsurance Ltd. (Merna Re) listed below:
–$500,000,000 tranche A ‘AAA’;
–$1,200,000,000 tranche B ‘AA+’;
–$850,000,000 tranche C ‘A-‘; –$690,000,000 tranche D ‘BB’;
–$780,000,000 tranche E ‘B+’.
The expected ratings address the likelihood that note holders will receive full payments of interest and principal in accordance with the terms of the transaction documents. These expected ratings are contingent on final documents conforming to information already received.
Russell emailed me the answer and as is typical of what Russell digs up on complex securities and derivatives the answer is not only fascinating but begs additional questions. First let’s do a quick refresher on why this question is topical here on Slabbed by starting with the then breaking news that Allstate’s special purpose entity Willow Re’s cat bonds were facing “imminent default“, followed by my explanation of the events that brought about the then imminent default (subprime mortgages backing the bonds). Then we linked a Reuter’s story reporting the actual default:
Willow Re and three similar deals used a unit of Lehman Brothers as total return swap counterparty, contracted to ensure the collateral backing the bonds was sufficient to meet interest and principal repayments, and to make up any shortfall.
When it collapsed, investors were left with direct exposure to market losses on assets held as collateral. S&P had said on Oct. 9 that it believed payments on Willow Re were at risk.
The default will not trigger a termination of the underlying reinsurance agreement between Allstate and Willow Re, meaning the bonds could still pay out to Allstate in the event of a severe windstorm in the northeastern United States. In that case, the exact payment received by the insurer would depend on the value of the collateral pool.
The loss of Lehman Brothers as the counterparty to the embedded total return swap is the direct cause of the Willow Re cat bond price plunge as the above story indicates. We can also reasonably infer the market “perceived” the value of the Lehman Brothers financial guarantee was around 50 cents on the dollar and the logic for that inference is straightforward because after Lehman imploded the value of the bonds went from around 100 to 50 (as in 100% of par value to 50% of par value). Is the implied value of the Lehman financial guarantee also a signal that Lehman was in for some troubled times? Continue reading “Anyone else curious why Allstate’s SPE WillowRe’s bonds are trading at half their par value?”
A catastrophe bond sold by U.S. insurer Allstate Corp (ALL.N) is in default after special purpose vehicle Willow Re failed to make in full an interest payment that fell due last week.
The transaction is among four catastrophe bonds guaranteed by a unit of Lehman Brothers that were downgraded by credit rating agency Standard & Poor’s following the U.S. investment bank’s Sept. 15 bankruptcy filing.
Given the current financial mess that resulted from unsound and ill advised financial practices my total amazement at certain of the state insurance regulators for allowing insurance companies to count such silly things as deferred income taxes in their capital computations is mind boggling. Anyone else remember the industry meme the past 6 months repeated by paid insurance industry shills like Robert Hartwig of the Insurance disInformation Institute that this was a bank problem and that insurers were financially strong? Financially strong enterprises don’t spend time getting regulatory blessing to cook their books. In fact I’ll go a step further and publicly advise what I’m telling my paying clients, If your bank or insurer counts silly things like their net deferred tax asset as capital, run don’t walk for the door. Simply put it means they are in severe financial distress. In Allstate’s case details have emerged in the national media as to the extent of their problem. We begin at the WaPo:
Allstate, the big insurer, last week declared that despite unprecedented trouble in the markets, it remains financially strong.
But tucked deep inside a company report is evidence that Allstate changed its bookkeeping last year in ways that improve its financial appearance.
One accounting change added $347 million. Another delivered a year-end boost of $365 million.
Allstate’s actions illustrate a broader risk to investors, policyholders and people looking for insurance. Insurers have been asking regulators to let them operate with thinner financial cushions or to pad those cushions with assets they could not otherwise count. For anyone trying to assess the companies’ financial strength, the changes can cloud the picture. That could make it harder for people to make sound decisions when buying policies or annuities to protect their families.
In hindsight it is clear Senate Majority Leader Harry Reid knew exactly what he was talking about last October when we welcomed him to slabbed, especially when we later found out bankruptcy for the Hartford was closer than Senator Dodd or they admitted. Turns out the Hartford liked very much hopping in bed with moneychangers and now finds itself about broke despite TARP. We’ve had national financial media all over our old slabbed threads on that topic and more yesterday so today it is no surprise to us the Wall Street Journal is reporting long lost brother Darrell is needing big help and unfortunately for them Susan Voss isn’t around to help them cook their books and count deferred tax assets toward the statutory TNW (tangible net worth). Predictably in$urance inc.’$ very own $enator Chri$ Dodd is doing his part beating the drum to suspend fair value accounting so we can all pretend the toxic mortgages and worthless financial guarantees the Hartford paid good money for are actually worth something (heckuva a job Chrissy):
The U.S. Treasury Department and the Securities and Exchange Commission are not discussing the suspension of a controversial fair value accounting rule blamed for billions of dollars in bank losses, a source familiar with matter said on Thursday.
Speculation that the U.S. government would suspend the accounting rule surfaced earlier on Thursday, sending U.S. stocks higher. But the source said no such discussions had taken place between the Treasury Department and SEC.
Key policymakers have suggested that the rule could be amended. Sen Christopher Dodd, the Democratic chairman of the Senate Banking Committee, said it might be possible to modify fair value accounting rules for banks facing steep write-downs of troubled assets without abandoning the underlying accounting standard.
Now down south we have a phrase for what Senator Dodd is doing. It’s called called pretending shit is shinola and let’s be honest this is really about the money and lots of it. Senator Dodd has been a faithful waterboy to the same bunch of Wall Street crooks that brought us the 2008 financial implosion so it’s no surprise he is still out trying to raid the treasury for his big business friends. From the sound of the story, his drum beating does not seem very effective which brings us to this breaking news story from the Wall Street Journal: Continue reading “The Hartford to Bankruptcy? Part M”