Cat bond rating
The grade an agency assigns to a principal-at-risk note by converting its modeled attachment probability into the default probability equivalent of a conventional bond.
Many institutional investors may hold only rated securities, and a cat bond has no issuer whose creditworthiness could be judged: its principal is lost if the catastrophe occurs, whatever anyone's financial condition. The agency therefore treats the attachment probability supplied by the modeler as a default probability and compares it with its default table for corporate bonds of the same term. The rating assigned is the weakest of three components: the catastrophe risk, the quality of the collateral assets and, if it pays part of the coupon, the sponsor's strength. The limit is obvious: the rating inherits every uncertainty in the model, and an update to the hazard model can downgrade several notes at once without any event occurring. For this reason most cat bonds sit in the speculative grade.
In September 2006, S&P revised its rating criteria for natural peril cat bonds: a matrix crossing the note's term with its attachment probability, with a cap of 'BB+' for a first-event trigger, 'BBB+' for a second-event trigger and 'A+' for a third, an 'AA' rating remaining possible from the fifth event onward if the events are independent.
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