NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns a 'Bsf' rating to the series 2014-1 class A principal at-risk variable-rate notes issued by Alamo Re Ltd., a duly formed special-purpose insurer in Bermuda as follows:
--$400,000,000 principal at-risk variable rate notes; expected maturity June 7, 2017.
The Rating Outlook is Stable.
The notes are exposed to insured catastrophe losses due to 'named storms' and its ensuing perils (such as wind, gusts, hail, rain, tornadoes) on an indemnity basis from subject business written by the Texas Windstorm Insurance Association (TWIA). The subject business covers the 14 first-tier, seacoast counties of Texas (and a small portion of Harris County). This represents $84.4 billion (as of Dec. 31, 2013) of total insured value that is primarily residential (85%) and commercial (15%) with very little exposure to mobile homes. Galveston and Brazoria counties represent 50% of the total insured value.
On a historical basis, there have been 37 hurricanes that have made landfall in Texas since 1900. Recent hurricanes, Dolly and Ike (two events in 2008) would have caused an estimated 26% principal loss to the notes. Hurricane Rita (2005) would not have caused any losses. Four hurricanes prior to 1933 would have totally exhausted the notes.
Initially, noteholders are subject to principal loss (and reduced interest) if annual aggregate ultimate net losses exceed the attachment point of $1.90 billion and a total loss of principal occurs if the severity reaches $3.25 billion in the first 12-month risk period. A named storm must generate at least $50 million in ultimate net losses to be included in the aggregate total. Based on the profile of the initial attachment point, the modeled annual aggregate exceedance probability is estimated at 3.80%, which implies a 'Bsf' rating per Fitch's criteria.
There are three annual risk periods over the term of the note. Thus, the notes will 'reset' on June 1, 2015 and June 1, 2016 using an escrow software model and TWIA providing updated subject business data. At each reset date, TWIA may exercise an option to adjust the attachment levels within an exceedance probability range of 4.40% to 1.75%. The implied rating under Fitch's criteria at a 4.40% exceedance probability is 'Bsf', and the implied rating at 1.75% is 'BB-sf'. If such an option is exercised by TWIA at either reset date, the risk interest spread will be recalculated to reflect the increased (or decreased) level of risk assumed by the noteholders. If TWIA does not elect to reset the attachment levels, the reset agent will adjust the attachment points to maintain the initial exceedance probability (3.80%) and initial annual expected loss using the updated subject business profile.
The notes may be extended for three additional years if certain qualifying events occur, or at the discretion of Hannover Rueck SE, a reinsurance company that acts as a transformer and sits between TWIA and Alamo Re. However, the notes are not exposed to any further catastrophe events during this extension. The notes may be redeemed at any time due to regulatory or tax law changes or partially by TWIA during the extension period or under early redemption events. The repayment of the notes to the noteholders occurs subsequent to any qualified payments to TWIA for covered events. Noteholders have no recourse to TWIA (or to its transformer, Hannover Rueck, SE).
KEY RATING DRIVERS
The rating is based on the weakest link amongst the evaluation of the natural catastrophe risk, the business profile of TWIA, the counterparty risk of the transformer (Hannover Rueck SE) and the credit risk of the collateral assets. The natural catastrophe risk represents the weakest link and currently drives the note rating.
The rating analysis in support of the evaluation of the natural catastrophe risk is highly model-driven. As with any model of complex physical systems, particularly those with low frequencies of occurrence and potentially high severity outcomes, the actual losses from catastrophic events may differ from the results of simulation analyses. Fitch is neutral to any of the major catastrophe modeling firms that is selected by the issuer to provide the model analysis, and thus Fitch did not include any explicit margins or qualitative haircuts to the probability of loss metric provided by the modeling firm.
The probability of loss was initially estimated at 3.80% based on a one-year simulated period as calculated by a third-party modeler, AIR Worldwide (AIR) using their methodology and proprietary models, but as noted, could be adjusted by TWIA to range between 1.75% and 4.40% at each reset period. Results from other possible modelers or from TWIA were not provided. Sensitivity analysis provided by AIR indicated the implied rating would be no worse than 'Bsf'.
The risk modeling included certain stresses for economic demand surge, storm surge and loss adjustment expense factor of 1.10. Debris removal was not explicitly modeled but is implicit in the claim data history. The modeled results did not include the possibility that the average annual loss may increase by 1.10 in any annual risk period. The model simulates only hurricane activity making landfall, thus it understates claim losses to named storms not recognized as hurricanes or hurricanes that become degraded. Noteholders are exposed to this basis risk or the difference between actual net losses incurred by TWIA and the AIR modeled net losses.
Alamo Re ultimately 'follows the fortunes' of TWIA in regards to underwriting of new business over the next three years and claim management practices. TWIA was established by the Texas Legislature in 1971 as a residual insurer of last resort. Although applicants must have been denied coverage by at least one commercial insurer, all properties insured by TWIA must be certified as built to specified building codes, must have flood insurance coverage in specified flood areas and have maximum limits per residential dwelling of $1,773,000 (higher limits are available for commercial structures).
Fitch believes certain other safeguards are in place for noteholders: TWIA is subject to review, oversight and approval by the Texas Department of Insurance (though it receives no federal, state or local funds for support); there is an independent claim reviewer and loss reserve specialist (Deloitte Ltd.) for Alamo Re; and the data quality of the subject business provided to AIR appears adequate.
For this particular peril and transaction, TWIA under the catastrophe bond will retain at least 5% of the aggregate ultimate net loss on a first-dollar coverage and employs a unique Class 2 and 3 public securities funded by non-refundable premium surcharges to policyholders and insurer member assessments for an additional $1.5 billion protection. Above the initial modeled attachment of $1.9 billion, claim losses are shared between noteholders and traditional reinsurers on a pro rata basis depending on the ultimate deal size.
Hannover Rueck SE (IDR: 'A+', Outlook Positive) acts as the transformer for TWIA and Alamo Re. Noteholders are exposed to the risk that Hannover Rueck SE does not pass along retrocession premiums to Alamo Re. These premiums are a key component in the coupon payment to noteholders.
Proceeds from this issuance will be held in a reinsured reinsurance trust account and used to purchase highly-credit-quality money market funds meeting defined eligibility criteria, otherwise funds will be held in cash. Investment yields generated from these permitted investments are passed directly to noteholders as the other component. A downgrade of a permitted investment will not necessarily lead to a replacement of that investment. Further, noteholders are exposed to possible market value risk if the net asset value of a money market fund falls below $1.00. Finally, certain actions may be required if the collateral account is invested in money market funds and FATCA is deemed to apply in late 2016.
A legal opinion regarding Alamo Re's consolidation with its owner, a Bermuda purpose trust, is not available. This opinion typically provides assurances that the issuer will not be consolidated with its owner in the event of its owner's insolvency. In this instance, Fitch gained comfort with a lack of such an opinion given that the owner is a non-operating company, there was no rating uplift on the note and Fitch's understanding of the lack of a concept of substantive consolidation under Bermuda law.
This rating is sensitive to the occurrence of a qualifying event(s), TWIA's election to reset the note's attachment levels, changes in the data quality or purpose of TWIA, the counterparty rating of Hannover Rueck SE and the rating on the assets held in the collateral account.
If a qualifying covered event occurs, Fitch will downgrade the note to reflect an effective default, and issue a Recovery Rating.
In the case of a reset election by TWIA, the rating would not be sensitive to a movement from the initial 3.80% exceedance probability to a probability as high as 4.40%, since both probabilities imply a 'Bsf' rating. However, if as of the June 1, 2016 reset date TWIA elects to move closer to an exceedance probability approaching 1.75%, the notes at that time could be upgraded to as high as 'BB-sf'.
The escrow model may not reflect future methodology enhancements by AIR which may have an adverse or beneficial effect on the implied rating of the notes were such future methodology considered.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Insurance Link Securities' (August 2012);
--'Global Structured Finance Rating Criteria' (May 2013);
--'Counterparty Criteria for Structured Finance Transactions and Covered Bonds' (May 2013).
Applicable Criteria and Related Research:
Global Structured Finance Rating Criteria
Counterparty Criteria for Structured Finance and Covered Bonds