An increase in primary catastrophe bond deal-flow, as well as the approach of the key reinsurance renewals on 1st January, stimulated greater liquidity in the secondary market for cat bonds in November.
Cat bond investors and insurance-linked security (ILS) investment fund managers have been busily re-positioning portfolios, in order to accommodate more than one billion dollars of new cat bond issues expected to close before year-end.
With five new cat bonds having been scheduled for December closing (Kilimanjaro Re 2015-1), Residential Re 2015-2, Nakama Re 2015-1, Vita Capital VI 2015-1 and Queen Street XI Re 2015), activity in the secondary market was driven by investors response to an expected primary market issuance.
The other factor that always drives secondary cat bond market activity at this time of year is the growth of collateralized reinsurance participation among the ILS fund managers and the approach of the January renewals.
These renewals see a significant number of worldwide retrocessional and regional property catastrophe reinsurance programs renewed, in which the ILS fund manager community are becoming increasingly large participants.
That means portfolio adjustments are common around this time of year, as ILS funds seek to create space to accommodate the end of year cat bond issues and to free up capital for collateralized reinsurance renewals.
There was also more stability in pricing in November, compared to October which saw a more rapid moderation of secondary cat bond prices as the U.S. wind and hurricane season neared a close. This year the seasonal effects seemed to leave the market early, even with the hurricane season not officially ending until the last day of November.
It’s the second year in a row that we’ve seen the seasonality dissolving in October, as investors saw little chance of Atlantic hurricane activity emerging and threatening cat bonds in what has been another very quiet year.
Craig Bonder, Managing Director at AK Capital, explained; “Another fairly active month in the secondary markets at AK as pricing levels towards the second half of the month appeared to settle into a comfort zone for both buyers and sellers. We saw a continual flow of short dated product both wind only and wind and quake and other low yielding names.”
The flow of “short dated product” and low yielding cat bonds is due to investors desire to maximise returns in cat bonds, as they try to offload lower yielding notes to accommodate any opportunities that are higher yielding in the primary market.
It also signifies a general lack of popularity in many lower yielding bonds now, which should eventually force the market to produce more risk at higher yield levels.
Bonder continued; “Overall as we head into December investors have successfully been able to find liquidity to generate cash for the upcoming new issue pipeline. Note while there were no new deals issued this month we did finally see a handful announced which also likely contributed to the price settling and spurs of trading activity.”
Swiss located ILS and cat bond investment manager Plenum Investments noticed similar trends in the secondary market during November.
“Due to the increase in primary market issuances, there was also more activity in the secondary market. Especially bonds with maturity dates before the next hurricane season were traded actively,” Plenum explained.
Plenum also noted that price movements were only marginal during November, as the market appeared to reach more an equilibrium on pricing.
“With the exception of US hurricane positions which corrected slightly, price movements were marginal,” Plenum said. However, “The price decline of US hurricane positions could not be offset by mark to market gains on European storm bonds.”
Some price gains should be anticipated on outstanding European windstorm catastrophe bonds in the weeks to come, as the season begins in earnest.
It will be interesting to see how the secondary cat bond market reacts should the first-quarter of 2016 see an average or above level of new issuance. At some point there could be a crunch on older, lower-yielding cat bond positions, which could become increasingly difficult to sell, an interesting dynamic to watch out for over the coming months.