Catastrophe bond issuance has jumped this year, after a complete standstill during the second half of 2008.
Catastrophe bond issuance has jumped this year, after a complete standstill during the second half of 2008. A recent report issued by Guy Carpenter & Co. revealed that nine bonds were issued in 1H09, ranging in size from $70 million to $250 million. Nearly $1.4 billion in bonds were issued through June.This activity represents a rise from the lull of issuance during the second quarter of 2008, yet is still lower than issuance numbers from the first half of last year, when eleven bonds were issued during the first half of the year, resulting in $2.4 billion of issuance.The cat bond market had seen demand since its inception in 1999, yet issuance was non-existent from August 2008 to February 2009 largely because of the Lehman Brothers bankruptcy.The bankruptcy resulted in defaults on the total return swaps that provided Libor on four bonds. Lehman’s failure highlighted the swap counterparty risk present in cat bond deals. “Lehman was the total return swap counterparty that provided collateral that would be there for investors,” said Rodrigo Araya, senior vice president at Moody’s Investors Service. “But there was default because the collateral was not a very good quality and resulted in potential losses for the investors. That was risk that they were not actually buying or being paid to take.” While these issues temporarily shutdown the cat bond sector, market players continued to look for solutions to the problems. Don Thorpe, senior director at Fitch Ratings’ insurance group said the “solutions to collateral and total return swap issues have been effective. The major roadblock has been removed.”In February of 2009, after six months of no cat bond issuance, Atlas V reopened the market by issuing cat bonds under the French insurer SCOR with a new and improved flop structure to help manage counterparty risk.When cat bonds came back to market, the prices were high compared to those of reinsurance, and consumer appetite was low. “After June, however, the tone flipped and now there is more investor appetite than issuance supply,” said Sean Casey, managing director on the capital markets desk of Bank of America/Merrill Lynch. “There were two deals done in July that performed extremely well - both were increased in size and their spreads were tighter than the first nine deals of the year. Now there is great investor appetite and the market should do very well over the rest of 2009 and into 2010,” Casey said.The two July deals — Parkton Re, a 144A $200 million cat bond deal, and Eurus II, a $210 million deal — achieved tighter spreads, which Chi Hum, managing director at Guy Carpenter Securities and co-author of the July 27 cat bond report, said he hopes will encourage issuance in the remainder of the year. A decrease in cat bond spreads could certainly result in additional issuance activity, especially for sponsors who deferred previous plans to issue deals because they considered cat bond spreads to be too wide, according to the Guy Carpenter report.Cat bond spreads were consistent from the first to second quarter of this year, up 25% to 50% relative to 2008 levels.The market reacted positively in response to the higher yields, with three of the quarter’s six transactions upsized relative to initial announced placement targets.Last month’s Parkton 144A cat bond deal, for example, was upsized to $200 million from $125 million.As Thorpe pointed out, the upsizing reflects the current appetite in the market for cat bonds, while Hum said the favorable execution of the deal in terms of price and size is “a signal that investors are willing to support new issuers with a well structured deal. We see this as a positive sign for growth of the cat bond market in the near term.” Currently, most 2009 issuers have been repeat issuers and often primary insurance and reinsurance companies, with primary companies becoming more regular issuers than reinsurers.Primary insurers ACE, Allianz, Allstate, Chubb, FM Global, Hartford Fire, Liberty Mutual and Travelers have all sponsored one or more bonds. Reinsurers Hanover Re, Munich RE, SCOR, Swiss Re, and USAA have also been frequent sponsors. According to Thorpe, companies sponsor cat bonds for a source of additional catastrophe capacity in a tight market.“It is particularly useful for reinsurers looking to purchase retrocessional reinsurance because many reinsurers do not like to buy from their competitors,” he said. “Cat bonds also have relatively little credit risk.”While initial investors were mainly insurers and reinsurers, there has been a shift in the last few years to include cut, hedge, and large pension funds.Main underwriters include newer firms such as Aon as well as traditional dominant firms such as Goldman Sachs, who had a 40% market share in the nine deals this year. Swiss Re had the second largest share at 20%.Hum listed three main causes of the renewed cat bond activity. Primary companies, he said, recognize the need to diversify sources of catastrophe capacity outside of the reinsurance sector. There is also a need to reinvest cashflow by dedicated insurance funds and to maintain a degree of portfolio risk diversification. There are also encouraging signs, he said, that spreads are reversing from the widening experienced in the first half of 2009.BofA/Merrill’s Casey said investors previously had more alternative investment opportunities with higher returns, but now they have returned their focus back to the cat bond market, where new investors are investing directly or through dedicated hedge funds.“Now assets are invested in government guaranteed paper often without a swap counterparty with structures where the assets can be sold at par,” Casey said.Conditions look favorable for the market. Maturities of $960 million are expected in the second half of this year, with the year-to-date total of matured risk principal at just over $2.24 billion. Additionally, the $3.7 billion of bonds to mature by January 2010 will provide a large cashflow to be reinvested.Also on a positive note, risk outstanding capital fell $779 million from the first quarter of this year to the second, from $12 billion to $11.2 billion, as maturities outpaced issuances. The 2Q09 was the second consecutive quarter in which total risk capital outstanding declined. The cat bond risk capital outstanding is now at mid-year 2007 levels.Currently, two cat bond transactions are planned for the third quarter of this year, one with European exposure and one with U.S. wind exposure. Of the nine deals issued so far, eight involved either hurricane or earthquake risk or both, and two involved European wind.Catastrophe bond issuance has jumped this year, after a complete standstill during the second half of 2008. A recent report issued by Guy Carpenter & Co. revealed that nine bonds were issued in 1H09, ranging in size from $70 million to $250 million.