Investors In Risky ‘Pandemic Bonds’ Just Got Wiped Out

Investors who, for nearly three years, collected hefty coupons on a multi-tranche pandemic bond, took a big hit on Friday when an independent arbiter officially ruled that COVID-19 met the conditions to trigger losses on the notes.

Investors in the riskier tranche will be wiped out to the tune of $95 million. The senior tranche – a $225 million note – will take a $37.5 million haircut, investors said, following a ruling by Boston-based AIR Worldwide Corporation.

The World Bank sold the bonds in 2017 following the Ebola outbreak in Africa. Investors enjoyed coupons of between 6.5% and 11.1% over Libor, but thanks to COVID-19, almost $133 million will be redirected to the institution’s Pandemic Emergency Financing Facility by mid-May.

Earlier this month, investors got a reprieve when AIR said the pandemic wasn’t yet viral enough (for lack of a better way to explain the rationale) to trigger the payouts.

Here’s how the World Bank explained the situation on April 9:

COVID-19 is one of the viruses covered by the PEF insurance window. Some of the activation criteria that must be met before a payout can be made, such as outbreak size and spread across borders, have already been met. The 12-week period (84 days) from the start date established by the WHO, December 31, 2019, ended on March 23, 2020.

The last criterion required to activate payment of the pandemic bonds: an exponential growth rate in IDA/IBRD countries as calculated by the third-party calculation agent (AIR Worldwide), has not been met. The next report by the calculation agent will be available on April 17.

Friday was April 17. And it was execution day for investors.

Some in the market were resigned to the notes’ fate, while others clung to the idea that the infection growth rate wouldn’t ultimately hit the mark. “One asset manager’s internal calculations pointed to a writedown, while another thought the growth rate was still not sufficient to trigger losses”, Bloomberg wrote, back on April 10.

The market itself made up its mind more than a month ago, when the riskier tranche started trading at just 10 cents on the dollar. The safer tranche was still being quoted at par in late February.

This is an interesting story, capturing as it does the evolution of securitization and risk transfer in an era when existential threats to mankind from natural disasters and catastrophes seem to be multiplying.

When the notes were issued in 2017, they came with a straightforward press release, which explains the structure in simple terms. To wit, from that press release:

The World Bank (International Bank for Reconstruction and Development) today launched specialized bonds aimed at providing financial support to the Pandemic Emergency Financing Facility (PEF), a facility created by the World Bank to channel surge funding to developing countries facing the risk of a pandemic.

This marks the first time that World Bank bonds are being used to finance efforts against infectious diseases, and the first time that pandemic risk in low-income countries is being transferred to the financial markets.

The bonds will be issued under IBRD’s “capital at risk” program because investors bear the risk of losing part or all of their investment in the bond if an epidemic event triggers pay-outs to eligible countries covered under the PEF.

The PEF covers six viruses that are most likely to cause a pandemic. These include new Orthomyxoviruses (new influenza pandemic virus A), Coronaviridae (SARS, MERS), Filoviridae (Ebola, Marburg) and other zoonotic diseases (Crimean Congo, Rift Valley, Lassa fever).

PEF financing to eligible countries will be triggered when an outbreak reaches predetermined levels of contagion, including number of deaths; the speed of the spread of the disease; and whether the disease crosses international borders. The determinations for the trigger are made based on publicly available data as reported by the World Health Organization (WHO).

Thankfully, this pandemic was of Coronaviridae sort. The morbid reality is that if there’s ever a pandemic of the Filoviridae type pervasive enough to trigger haircuts on pathogen-linked bonds, we’re all going to be far too concerned with the pressing matter of preserving the human race to care about the haircut.

In any case, it’s all over now but the technicalities, apparently. This money will eventually make its way to poor countries, with the only question being whether it will be too late to make a difference.

Ultimately, payouts won’t come until at least 136 days from the start of the pandemic, a fact which has already drawn criticism and is bound to engender calls for subsequent issuance of similar notes to come with a more flexible structure.

As you can see from the summary terms and conditions below (from the World Bank), the notes would have matured in July.