IBRD / FONDEN 2020

The government of Mexico has returned to the catastrophe bond market with the help of the World Bank and its International Bank for Reconstruction and Development (IBRD), seeking a $425 million or larger slice of parametric earthquake and hurricane disaster insurance from the capital markets with this issuance that is the first to incorporate sustainable development bond features.

This latest catastrophe bond from the World Bank and IBRD has a twist to it, in that it is the first ever cat bond where the proceeds from the sale of the notes can be used by the IBRD to finance sustainable development projects in its member countries.

It’s a hybrid structure, incorporating elements of a sustainable development bond alongside a catastrophe bond, a concept that has been broadly discussed around the market as one way to tap into investor appetite for ESG assets.

It’s assumed that means the IBRD can use this liquidity within its developmental programs and projects, but if the catastrophe bond is triggered it will make up the collateral to the agreed amount.

In this way it is a kind of sustainable development bond investment, as well as a catastrophe linked investment, at the same time. Which may help to open up the market to an increased range of institutions and investors, broadening the insurance-linked securities (ILS) investor base.

For this new IBRD / FONDEN 2020 catastrophe bond, which we’ve named as such as the issuance has no other defining series details right now, FONDEN, the natural disaster insurance fund of Mexico, is the ultimate insured along with its trustees.

The trustee of FONDEN acts as the insured for the coverage, entering into an insurance agreement with the Mexican government-owned insurer Agroasemex S.A.

Agroasemex S.A. then enters into a reinsurance arrangement with Swiss Re, who act as the ceding reinsurance firm, and Swiss Re in turn enters into retrocessional agreements with the IBRD, the issuer of the notes.

In this case, the retrocessional reinsurance agreements will be capitalised by the sale of four tranches of catastrophe bond notes, that will be sold to capital market investors to fully collateralise the transaction.

There will be two tranches of earthquake-linked notes issued, as well as one tranche of notes covering Atlantic named storms and one covering Pacific named storms, so providing protection for the two main natural disaster perils Mexico faces, hurricane and earthquake risks.

All four tranches of notes will provide their disaster insurance coverage to the Mexican government on a parametric trigger and per-occurrence basis across a four-year term, we understand.

The covered area for both perils are the exposed areas of Mexico, as well as some small overlapping areas of the United States where earthquakes could occur and still cause significant damage in Mexico, or a hurricane could come ashore and breach the parametric trigger in the U.S. but then impact Mexico significantly as well.

At this time the transaction is offering cat bond investors $425 million of notes across the two perils of wind and quake in four tranches of catastrophe-linked Capital At Risk notes to be issued by the IBRD, we’re told.

A $125 million tranche of Class A notes is a lower-risk earthquake exposed tranche of notes, having a modelled expected loss of 0.9% and price guidance of 3% to 3.5%.

A $100 million tranche of Class B notes is a higher-risk earthquake exposed tranche, with a modelled expected loss of 5.78% and price guidance of 8.25% to 8.75%.

A $100 million tranche of Class C notes will cover named storms and hurricanes on the Atlantic coast, with a modelled expected loss of 5.61% at the base case and price guidance for investors of 10% to 10.5%.

The final tranche is a $100 million Class D layer, to cover named storms and hurricanes on the Pacific coast of Mexico, which have a modelled expected loss of 4.06% and are offered to investors with price guidance of 6.75% to 7.25%.

We understand the parametric trigger for earthquake risks is based on magnitude and location of occurrence, with Mexico broken up into boxes for each tranche of notes and payout rates of 25%, 50%, 75% and 100% of principal determined by where a quake strikes and how powerful it is.

That’s the same kind of trigger as previous World Bank earthquake cat bonds for Mexico, but we’re also told that the boxes are now much smaller around significant population centres, to allow for a more highly calibrated parametric trigger to enhance the protection.

On the named storm and hurricane side, the parametric trigger design is similar again to previous World Bank catastrophe bonds for Mexico’s FONDEN.

That means there is a line along the Atlantic and Pacific coasts, for the respective tranches of notes, over which a hurricanes eye needs to pass with a certain minimum central pressure or lower for a payout of 25%, 50% or 100% to become due.

Hence, it is location and severity that are the core components of both earthquake and hurricane parametric triggers and will define whether any tranches of this new Mexico catastrophe bond pay out over the four years it is in-force and providing the country with disaster insurance protection.

Update 1:

This issuance is now targeting from $410 million to as much as $525 million of disaster insurance protection from the capital markets, making it the largest so far from Mexico and more than a replacement for the soon to mature $260 million 2018 issuance IBRD CAR 118-119.

The first tranche of Class A notes, a lower-risk earthquake exposed layer, launched targeting $125 million of protection for Mexico from notes having a modelled expected loss of 0.9% and price guidance of 3% to 3.5%. Now, we’re told, this tranche is targeting an upsized $150 million to $175 million of coverage, with price guidance now fixed at the top-end of guidance at 3.5%.

What was a $100 million tranche of Class B notes, a higher-risk earthquake exposed layer with a modelled expected loss of 5.78% and initial price guidance of 8.25% to 8.75%, is now targeting $60 million to $100 million and with tightened price guidance of 8.75% to 9%, so at the top-end or above of initial spread guidance, we understand.

What was a $100 million tranche of Class C notes, covering named storms and hurricanes on the Atlantic coast and with a modelled expected loss of 5.61% at the base case, had initial price guidance for investors of 10% to 10.5%. This tranche is now marketed as targeting $100 million to $125 million with price guidance tightened to 10% to 10.25%.

The final $100 million Class D tranche, covering named storms and hurricanes on the Pacific coast of Mexico with a modelled expected loss of 4.06% , were initially offered to investors with price guidance of 6.75% to 7.25%. This tranche is now also targeting $100 million to $125 million with price guidance tightened to 6.5% to 6.75%.

From the way the pricing has moved it looks like investors demanded more spread on the earthquake exposed layers of notes, perhaps a reflection of recent quake activity in the country, but also of losses paid historically for Mexico from its catastrophe bonds.

Update 2:

At pricing, the IBRD / FONDEN 2020 catastrophe bond sponsored by the Mexican government upsized by 14% to settle offering $485 million of capital markets backed natural disaster insurance protection.

The Class A notes, a lower-risk earthquake exposed layer, secured the upper-end of the targeted range at $175 million in size, but at top-end of pricing at 3.5%.

The Class B notes, a higher-risk earthquake exposed layer, were priced at $60 million in size, we’re told, the lower-end of the target, with pricing of 9%, so the upper end of revised guidance and above the initial guidance range.

The Class C tranche of notes, covering named storms and hurricanes on the Atlantic coast priced at $125 million in size, with pricing of 10%, so at the lower-end of initial guidance.

The final $100 million Class D tranche, covering named storms and hurricanes on the Pacific coast of Mexico, also achieved the upper-end of the targeted size at $125 million, with pricing of 6.5% actually below the initial guidance range.

So a mixed result in terms of demand and pricing, with the riskier earthquake layer of notes seemingly less popular with the cat bond investor base.

Update – October 25th 2023:

The Class D tranche of notes are likely to face a loss of principal after hurricane Otis made landfall as a severe category 5 storm near Acapulco on Mexico’s Pacific coast, with a minimum central pressure reported at 923 mb.

That’s well below the parametric trigger threshold for a 25% loss of the $125 million of Class D note principal, and it’s now through likely to prove to be below the threshold required for a 50% loss of principal to occur. More details.

The market is currently anticipating a 50% loss of principal to the Class D notes due to hurricane Otis, which would equate to a $62.5 million payout to the Mexican government’s Treasury to assist with disaster recovery and reconstruction.

Update – March 8th 2024:

The U.S. National Hurricane Center (NHC) has delivered its final tropical cyclone report for 2023’s hurricane Otis, putting the minimum central pressure of the storm at 922mb and at 929mb at landfall on the Mexican coast, which we’re told still suggests the $125 million IBRD / FONDEN 2020 Class D tranche of catastrophe bond notes face around a 50% loss.

Sources said that early analysis shows that the central pressure may have been around 924mb at the time Otis breached the parametric trigger, which would support a roughly 50% payout of the $125 million of notional. However, the calculation agent must run its process, which we understand takes 5 working days, so until that determination is available the payout amount can not be considered final.