Capitol Re Corp. yesterday said an affiliate would take a $4.8 million loss reserve due to an expected corporate note default at 55 Water Street, a Manhattan office tower reeling from the commercial real estate recession.

The loss reserve will result in an after-tx net income reduction of about $1.5 million in 1992, the company said.

The expected losses are small compared with the firm's income and capital base. As of the first quarter of 1992, Capital Re was on a pace to earn more than $27 million this year, and its stockholders' equity was more than $196 million.

Nevertheless, equity investors yesterday reacted with alarm, driving the firm's common stock down $2.88 per share, or 13% to $19.63. about 380,000 shares changed hamds on the New York Stock Exchange; Capital Re just went public on April 8.

The Water Street building is managed by Toronto-based Olympia & York, which filed for bankruptcy May 14, but the exposure in question is secured soley by the property.

"This is an isolated event," said Alan roseman, general counsel to Capital Re. "Our exposures to commercial real estate are minor. We have no other [Olympia & York-related] exposure and no other below-investment-grade transactions.

"This is not indicative of our larger portfolio," he added. When the deal was structured, the notes were rated A by Standard & Poor's Corp.

Mr. Roseman said the $4.8 million estimate is based on statements from Olympia & York Water Street Finance Corp. that between expected lease payments and the remaining cash in operating accounts, interest payments on the debt would be made through 1993.

There is some question, however, whether the 1993 payments will come through.

On Wednesday, Olympia & York told bondholders that about $10 million should be in the operating account July 1, 1993, but it cautioned that if all the funds went to debt service, attracting new tenants would be nearly impossible.

In effect, the real estate conglomerate said bondholders could decide whether the operating funds go to building maintenance, property taxes, or paying interest on the debt. according to an analyst attending the meeting.

The building is expected to be 40% vacant in July 1993, according to Olympia & York. Analysts expect bondholders to end up owning the Wall Street-area building.

"We're shoulder-to-shoulder with the bondholders," Mr. Roseman said.

Capital Re's loss provision allows a glimpse into the world of municipal reinsurance and its organization.

The exposure results from a 1991 secondary -market transaction in which part of the $548 million first-mortgage corporate issue was repackaged and insured by Credit Reinsurance Co., an insurer 48.5% owned by Capital Re. That transaction was a Eurobond private placement, which, in turn, was reinsured by Capital Re's principal subsidiary, Capital Re Co.

Credit Re, then, has the more significant exposure. capital re's reinsurance of Credit Re is an "excess-of-loss" arrangement, Mr. Roseman explained, meaning only after the Credit re position has been paid in full would Capital Re be tapped.

The other 51.5% of Credit Re is owned by the same institutional investors holding Capital Re's private stock, primarily United States Fidelity & Guaranty Co., sibag Finance Corp., and Constellation Investments Inc.

Credit Re is on the hook for $13.5 million, but officials at this point expect $4.8 million to cover the damage.

"There is money to make payments, but we're trying to assume a little worse than that," Mr. Roseman said. "It's hard to determine at this point in time where it's going to be in 1996. This is basically what we can estimate as being probable at this time."

Standard & Poor's Corp. rates Capital Re AAA. Officials with the rating agency were not available for comment yesterday.

Credit Re was created in 1990 to provide Capital Re a vehicle for doing overseas reinsurance business. The company is headquartered in Bermuda and facilitates the municipal reinsurer'd organizational link to its new Paris office.

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