Cat bond was one of four for which Lehman Brothers was swap counterparty

Standard & Poor's has revised its rating on Willow Re Class B 2007-1 principal-at-risk variable-rate notes to 'D' from 'CC' because of an imminent interest payment default.

Willow Re (sponsor Allstate) was one of four cat bonds for which Lehman Brothers was swap counterparty.

The ratings agency had lowered its rating on the notes to 'CC' on 9 October 2008, because of the notes' exposure to the assets in the collateral account. At that time, S&P had indicated that the scheduled payments could be at risk.

The default will stem from the basis risk between the assets in the collateral account and the rated notes. The interest rate on the notes is based on the three-month US$ LIBOR, which reset on 1 October, 2008, while interest on a portion of the assets in the collateral account is linked to the one-month US$ LIBOR. Since the last interest rate reset on the notes, one-month US$ LIBOR has dropped significantly, so the assets are not generating enough cash to cover the scheduled interest payment.

The scheduled payment date is 2 February, and under the transaction documents, there is a five-day grace period until a default is triggered. S&P took the rating action because the issuer has notified the rating agency that it will not have sufficient funds to make the scheduled interest payment.

The other cat bonds for which Lehman was swap counterparty were Newton Re, whose sponsor was Catlin; Ajax Re (sponsor Aspen Re) and Carillon (sponsor Munich Re). The Chapter 11 filing caused a notice of event of default under the swap agreement.