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27 Nov 2007
Moody's rates Cyrus Reinsurance II Ltd's proposed bank loans
New York, November 27, 2007 -- Moody's has assigned the following ratings to three proposed bank loans
of Cyrus Reinsurance II Limited ("Cyrus Re II"): Ba1 to the $65
million senior secured term loan, Ba3 to the $20 million
senior subordinated secured term loan, and B3 to the $20
million junior subordinated secured term loan.
"Cyrus Re II is a type of limited purpose reinsurer that is commonly referred
to as a 'sidecar'," explains senior analyst Kevin Lee. "The
sidecar will be capitalized with $35 million of equity and $105
million of term loans (75% debt, 25% equity),"
notes Mr. Lee. "The term loans are arrayed in tranches,
each having a different probability of attachment, expected loss,
and priority with respect to interest and principal payments, hence
the difference in ratings."
Cyrus Re II is expected to provide collateralized quota share coverage
exclusively to two subsidiaries of XL Capital Ltd (NYSE: XL) --
XL Re Ltd (Aa3/stable) and XL Re Europe Ltd (the "Ceding Companies").
If the quota share agreement is executed, the Ceding Companies will
pass on (cede) -- and Cyrus Re II will assume -- 10%
of the premiums and losses on a future portfolio of non-proportional
catastrophe reinsurance contracts. Those underlying contracts will
be written in 2008 and will cover natural catastrophe risks throughout
the world. The future portfolio is expected to be similar to the
Ceding Companies' existing portfolio as client retention tends to
be relatively high. This quota share agreement, if executed,
will be distinct and separate from the Ceding Companies' previous
sidecar, Cyrus Reinsurance Limited.
The ratings for the term loans are supported by Moody's financial modeling
to determine both the probability of default ("PD") and expected loss
("EL") to lenders. The most important inputs into the financial
model are the annual aggregate probability loss curve derived by the Ceding
Companies (the "Base Curve"), premium assumptions, and investment
income assumptions. Moody's applied stress factors and performed
sensitivity analysis on all three inputs (see below). The PDs and
ELs from our simulation runs were then compared to Moody's idealized default
rates and expected loss rates over a weighted average life of about 1.7
years for each loan. Finally, the assigned ratings also reflect,
in our opinion, sufficient alignment of interests between stakeholders.
For more information on Moody's approach to rating sidecars, as
well as a comparison of sidecars and cat bonds, please refer to
our special comment titled "Reinsurance Sidecars: Moody's Five Principles",
dated March 2007.
Key rating factors include:
1) MODEL RISK: Catastrophe modeling error is the most important
risk factor. The Ceding Companies modeled their existing portfolio
using RMS 6.0 peril models that are common in the industry.
Parameter uncertainty, the quality of input data, and how
the models are used can all contribute to modeling error.
In general, the current portfolio is diversified with respect to
geography and layers of coverage. A majority of the current portfolio
consists of personal lines and standard commercial risks which generally
offer more homogeneous data than industrial and surplus lines risks.
The Ceding Companies receive exposure data from clients or brokers for
nearly all underlying contracts, allowing the Ceding Companies to
duplicate the modeling work with all discretionary (more conservative)
settings applied (e.g., near-term hurricane
event rates, secondary perils like storm surge, fire following
and, when feasible, sprinkler leakage, loss amplification,
and secondary uncertainty). One notable exception is assumed retrocession
business (2.5% of current portfolio limits), for which
exposure data isn't available, but is nonetheless modeled
by the Ceding Companies. Many of the covered perils are modeled
using RMS 6.0 peril models. European Flood, European
Earthquake and attritional losses (e.g., Midwest floods,
brushfires, etc.) are modeled using in-house curve
Moody's has applied a moderate load to the Base Curve to account
for the following elements: 1) potential deviations from the expected
portfolio (e.g., exposure growth and change in mix);
2) difficult-to-model classes of business such as industrial
and surplus lines risks (estimated to be roughly 20% of current
portfolio limits); 3) non-modeled contract elements such as
loss adjustment expenses and extra-contractual obligations (i.e.,
bad faith claims); 4) inherent uncertainty in peril modeling especially
as it relates to perils like earthquakes where little historical data
is available for model calibration; and 5) a small load for perils
that are not modeled by any methods such as volcanic eruption, meteorite
impact, tsunami, domestic terrorism and industrial/residential
2) DEFAULTS ARE SENSITIVE TO RATE AND INVESTMENT INCOME ASSUMPTIONS:
Our analysis suggests that default rates and expected loss rates to debt
holders are sensitive to assumptions about premium rates and investment
yields. This is fairly intuitive given that equity capital is thin
(75% debt, 25% equity) and tranche attachment points
are relatively low. That is to say, investors will have to
rely more on premium income and investment income to defray losses.
Premium rates in 2008 are uncertain. In our financial modeling,
we have modeled for the possibility that rates may fall up to 20%
from their 2007 levels. Additionally, we have modeled investment
3) ALIGNMENT OF INTERESTS: In Moody's opinion, there is adequate
alignment of interests between stakeholders given that the Ceding Companies
will retain 90% of premiums and losses with ample skin in the game.
Additionally, any reinsurance purchased by the Ceding Companies
for its retained portfolio would inure to the benefit of the sidecar.
Dividend distributions to shareholders are prohibited, mitigating
some of our concerns about the highly levered capital structure.
4) CASH WATERFALL: At each quarterly interest payment date,
trust assets that exceed loss reserves and a reserve cushion can be released
to pay interest. However, capacity must exist to fully pay
all remaining scheduled interest and principal on the senior secured term
loans before any trust capital can be released to pay interest and principal
on the senior subordinated or junior subordinated loans. The same
rule applies to the priority of payments between the senior subordinated
and junior subordinated loans. This cash waterfall is reflected
in our financial modeling.
The following ratings have been assigned with a stable outlook:
Cyrus Reinsurance II Limited -- $65 million senior
secured term loan at Ba1;
Cyrus Reinsurance II Limited -- $20 million senior
subordinated secured term loan at Ba3;
Cyrus Reinsurance II Limited -- $20 million junior
subordinated secured term loan at B3.
Cyrus Reinsurance II Holdings SPC is majority-owned by investment
funds affiliated with Highfields Capital Management LP. Its subsidiary,
Cyrus Reinsurance II Limited, is a Class 3 Bermuda reinsurer ("sidecar")
that is expected to enter into a collateralized quota share reinsurance
treaty with XL Re Ltd and XL Re Europe Ltd (the "Ceding Companies").
The treaty will cover policies incepting between January 1, 2008
and July 1, 2008. Lenders will be at risk for events occurring
between January 1, 2008 and July 1, 2009. Capital cannot
be returned to investors before September 1, 2009 and equity capital
cannot be returned to shareholders until all three loans have been repaid.
For more information, visit our website at www.moodys.com/insurance.
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service
Financial Institutions Group
Moody's Investors Service
No Related Data.
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