Despite 2013 seeing the second highest level of catastrophe bond and insurance-linked security (ILS) issuance on record a feature of the year was rising secondary market prices and this trend continued into December.
Demand for catastrophe bond and ILS paper has outstripped supply all the way through 2013, with secondary prices seeing mark-to-market increases as demand from investors bid up positions on outstanding cat bonds and ILS.
December saw a number of new cat bond issues complete, but it seems that this $1.1 billion of new risk capital was not sufficient to satisfy investor demand as some secondary cat bond positions continued to see price increases during the month.
Another interesting feature of 2013 has been the almost immediate mark to market price increases seen on newly issued catastrophe bonds. Cat bonds and ILS are issued into the secondary market at 100bps, but the last year has often seen new issues under such heavy demand that prices rise by 1 to 2 basis points within days of the transactions settlement.
This has resulted in some cases where investment managers have bought into a cat bonds launch issuance only to flip the notes on the secondary market to another investor for a small profit within days. In 2013 this has been a viable strategy for some ILS managers looking to make the most of this strong demand for capacity.
At times in 2013 the demand for cat bond and ILS notes on the secondary market has softened the seasonality effect of perils, resulting in some cat bonds gaining in value even during the U.S. hurricane season and contributing to gains made by ILS fund managers.
Looking at various examples of secondary cat bond and ILS pricing there are currently no listed tranches with guideline offer prices of below 100bps. In fact there are only a handful with bid price guidance below 100bps and all of these are above 99bps, showing that if you want to buy almost any cat bond or ILS on the secondary market you should expect to pay an above par price for it.
Of course this makes new issuance even more attractive to investment managers looking to deploy new capital they have raised, which furthers the cause of sponsors in trying to secure the best launch coupon pricing they can. While the supply, demand imbalance remains we could see further pressure on new issue pricing and prices on secondary positions remaining largely above par.
For new investors and investment managers seeking to acquire cat bond or ILS notes on the secondary market this presents a conundrum. The above par pricing effectively reduces the return to maturity potential of the cat bond or ILS note, reducing the attractiveness of some positions considerably if they already had a low coupon.
Strong primary issuance is required to level out the supply, demand imbalance and reduce pressure on some of these above par secondary market prices. How strong that primary issuance needs to be is hard to say, but it certainly needs to outstrip future maturities in order to soak up some of the excess or new capital in the ILS market.
December did see a slowdown in these price rises, as strong issuance during the month took some pressure off the secondary market, but as soon as issuance slowed and we moved into the new year outstanding cat bonds have again seen some prices moving further above par in January.
During December, ILS investment manager Plenum Investments said that secondary market price movements were inline with seasonal expectations. Plenum said that U.S. hurricane and Japan typhoon cat bonds continued to see wider spreads with an average price decrease of 45 and 40 basis points while earthquake bonds remained flat. European winter storm cat bonds gained a small amount, just 25 basis points, perhaps showing that the abundance of European windstorms has not impacted pricing at all.
Further price gains are expected in the first-quarter of 2014, according to specialist ILS investment manager, LGT Insurance-Linked Strategies, who said that it expects to see more price gains on secondary cat bonds due to a current shortage of new transactions.
Theis secondary market price environment has also allowed savvy investment managers to make a profit on cat bond positions they may have held for many months, selling them for above par prices. Credit Suisse is one example of a manager who took advantage of secondary cat bond prices in 2013.
Over the course of the year Credit Suisse chose to strategically move out of many cat bonds in search of better returns from collateralized reinsurance, however the ILS manager noted that some of these were so attractively priced that they were trading at a premium when sold.
LGT Insurance-Linked Strategies also said that the high level of investor interest for cat bonds is likely to remain strong into 2014, but the ILS manager believes that competition for investments will level out a little as new issuances come to market.
The opinion of many in the market is that primary issuance may be sluggish to start 2014 but will pick up into late February and March. Some are forecasting another $7 billion+ year of issuance, but a number Artemis has spoken with suggest a similar year to 2012, so outstripping maturities but not quite as much growth as seen in 2013.
Of course there are many factors which affect primary issuance and it could be much higher if a number of large deals were placed into the capital markets. Imagine if the Florida Hurricane Catastrophe Fund secured its entire $1.5 billion from a cat bond issuance, for example.
Secondary market prices and conditions may remain a little difficult for some, particularly new investors seeking to get into the cat bond space, for the moment it seems. A significant amount of primary issuance is required to reduce the demand for secondary marks, we’re being told. Although, if we see some real seasonality this year due to a more active hurricane season that could be just the stimulus that the secondary cat bond market needs.