A longstanding leading issuer of munis, New York’s Metropolitan Transportation Authority (MTA) took an entirely new approach to the capital markets this past July: a catastrophe bond.
The $200 million deal came nine months after Hurricane Sandy, but the storm, in a sense, begat the bond, as the insurance market’s capacity re-trenched in the aftermath and the MTA scrambled for alternatives. This was a classic case of heaping insult on injury—the agency already faced a staggering price tag from Sandy. The most recent estimates put the total losses to the MTA incurred by Sandy to $5.1 billion.
The bulk of that figure, about $4.8 billion, stemmed from direct damage to the MTA’s infrastructure. Another roughly $350 million was caused by lost fare and toll revenue as well as expenses associated with restoring service.
The tidal surge and high winds that came with Sandy inflicted damage throughout the MTA. Casualties included a number of subway stations—some fully submerged; under-river tubes; train yards and bus depots. Also hit hard were the subway line to the Rockaways in far southeast Queens. The Queens Midtown Tunnel between Queens and Manhattan and the Hugh L. Carey Tunnel, known more broadly as the Brooklyn-Battery Tunnel, were flooded.
Restoration funds will come mostly from insurance and federal re-imbursement. The MTA will fund an additional portion through the issuance of bonds.
The agency’s decision to use cat bonds to insure against potential losses from another storm illustrates how necessity can push a borrower to try something new, and in the process open a door to a funding source that could be tapped again.
“This is clearly a new option for us, which is why we were excited this deal was so well received in the market because it gives us alternatives,” said Laureen Coyne, director of risk and insurance management at the MTA.
The transaction was upsized from what was widely understood to be $125 million initially to $200 million. Standard & Poor’s assigned a BB’ rating to the deal, which priced at 450 basis points over U.S. Treasury Money Market earnings. The bond is backed by a reinsurance agreement between the issuer, MetroCat, and MTA insurance unit First Mutual Transportation Assurance (FMTAC). Under the terms of the deal, FMTAC gets three years of per-occurrence reinsurance protection against storm surge. It is the first time a cat bond has been linked solely to this peril.
The MTA renews its insurance program annually on May 1. This year, the agency faced a contraction of coverage options in the Sandy aftermath. Supply dwindled and prices spiked. The MTA was looking to place about $1 billion in reinsurance, $800 million of which was catastrophic insurance. At renewal time, the agency placed about $500 million of the total it was seeking via traditional insurance. The cat bond subsequently added another $200 million of coverage. The remaining $100 million was unplaced.
GC Securities was the sole bookrunner as well as a joint structuring agent with Goldman Sachs.
Given the timing, the MTA was iffy on the sort of reception it would receive from investors. “We were not sure what capacity was available [as] we went to the market fairly late in the season,” said Nora Ostrovskaya, senior manager of strategic initiatives at the MTA.
Historically sponsors want to have their reinsurance capacity before hurricane season gathers strength in July. But one cat bond source said that with new capital entering the market, players found this year they can market a deal up to August. This may be closer to the norm in the future.
In contrast to the MTA’s insurance coverage, the protection furnished by the cat bond is fully collateralized. The proceeds sit in a trust that can be tapped if the surge triggers are tripped. In the agency’s traditional program, the coverage is not necessarily collateralized, so the FMTAC must go through a claims process.
Another difference between the cat bond and the MTA’s traditional insurance contracts is the former’s focus on a specific peril: storm surges.
The cat bond has what is known as a parametric trigger: one that is based on a hazard and not the actual claims prompted by a disaster. In this particular case, if certain surge levels occur during a named storm and therefore hit the triggers pre-set by the transaction, then Metrocat makes a loss payment to FMTAC that is 100% of the principal amount. This is the main risk by the bondholders, that they could lose their principal.
By comparison, a number of cat bonds have triggers that are linked to actual losses or claims.
The risk modeling agent used in the transaction is Risk Management Solutions. S&P said the deal’s creditworthiness is linked to the modeled probability that there would be a triggering event, which would be an “event index value” equaling 8.5 feet or higher for zones labeled A’ (tidal gauges located in The Battery, Sandy Hook and Rockaway Inlet) and 15.5 feet or higher for B’ zones (tidal gauges in East Creek and Kings Point). The event index is tied to the height of the surge in the gauge areas.
An MTA spokesman said the agency did extensive modeling post-Sandy and found a strong correlation between flooding within the proximity of these gauges and damage to the agency’s assets.
The tidal gauge in The Battery, for instance, is near the Manhattan end of the Brooklyn-Battery Tunnel, near a number of key MTA facilities. The other triggers are also in zones that are strong predictors of damage. Sandy Hook, the end of a peninsula in New Jersey, is southeast of, and further into the Atlantic, than the southernmost borough of Staten Island, while Rockaway Inlet is the strait that links Jamaica Bay, east of Brooklyn, and the Atlantic Ocean. Another gauge, at Kings Point, is in the northern portion of the city, measuring a surge coming in from the Long Island Sound.
The MTA’s traditional property insurance contracts are split into two camps: all-risk and catastrophic perils. An all-risk contract would cover events such as fire, while catastrophic peril would cover not only storm-related surge damage but also damage caused by winds, floods and earthquakes.
Among perils, surge-related damage has the highest probability of losses for the MTA. That, along with the parametric nature of a certain kind of cat bond, led the issuer to hang the cat bond’s risk entirely on specific surge levels. But the agency said it was open to using cat bonds for other kinds of peril.
In May 2014, the next time the MTA will be shopping for reinsurance, it will have $200 million less it will need to renew as the cat bond’s coverage runs for three years.
Now that the MTA has cut its teeth in the cat bond market, would it consider securitization for its other funding needs?
Currently the agency has $32 billion in outstanding debt that is of a tax-exempt muni nature. Two of its more popular programs—transportation revenue bonds and dedicated tax fund bonds —are not candidates for ABS because they are backed at least in part by tax revenues, according to MTA spokesman Aaron Donovan.
He added that a securitization of toll revenues is not out of the question but so far at least it is debatable that going that route would make economic sense.