The mismatch between supply and demand in the catastrophe bond market persists and could now become accentuated, as the market pipeline of new cat bond deals continues to expand.
Right now, we’re tracking an impressive fourteen new catastrophe bond series that are being marketed to investors and are yet to complete, twelve of which have not even reached their final pricing.
This is a particularly long pipeline of new deals that are already in the marketplace, but with additional transactions still yet to launch to the insurance-linked securities (ILS) investor community, or that have yet to come to light to us through our market sources, the market for new cat bond issuance is perhaps as busy as it has ever been.
This translates to a lot of work and effort for the catastrophe bond market, for the broker dealer teams of structurers and bookrunners, the cat bond fund investors and ILS fund managers, the lawyers, risk modelling firms, trustees and other service providers as well.
Cat bond deal arrangers and cat bond fund investment managers have been discussing the mismatch in the cat bond market, with the effect seen that prices have been driven higher in the majority of new issues of late.
Principal among the factors causing the mismatch is risk appetite, which goes for both the appetite of specialist cat bond funds and ILS investors to assume risks and their demand for higher returns, as well as the current appetite of allocators to deliver more capital into the space.
That second point, the appetite of allocators to deliver inflows to cat bond and ILS funds is being significantly influenced by external factors right now, with the conflict in Ukraine, inflation, rising interest rates and huge volatility seen in other markets such as bonds and equities, all making end-investors and allocators nervous.
As Leadenhall Capital Partners CEO Luca Albertini told us recently in a video interview, there has been “a lot to distract investors” and allocators of late. This distraction continues and is a factor in cat bond market conditions at this time.
But beyond the appetite of investors and how that mismatches with the ambitions of sponsors, in terms of pricing, the other mismatch we’ve been explaining in our reporting is more specifically related to the levels of issuance activity being seen in the catastrophe bond market and how that matches with available capacity.
This continues to be a concern, we understand, especially so now the pipeline of deals is building to perhaps record levels. As we said, we’re not sure we’ve ever seen fourteen series of cat bonds being marketed or offered to investors all at once.
This mismatch, in terms of available capital or cash on-hand, plus capital that can be rolled-over from maturing cat bonds, versus the capital needed to support all new issues and meet sponsors needs, was cited as a bit of a problem by our sources a few weeks ago.
But with cat bond market activity accelerating as the reinsurance renewals approach, it doesn’t seem likely to disappear and is having an exacerbating effect on the spread widening we’ve been seeing, multiple sources have said.
Right now, the cat bond market pipeline shows no signs of slowing down and while some of the deals in the market are now moving towards final pricing, at which point their allocations will be set, we’re also told there are likely more cat bonds to come as well.
Aon had recently said it expected the spread widening seen in cat bonds would only persist for a relatively short period of time, but it does now seem likely it will run until the market pipeline slows right down for the summer months, as it typically does.
We have been told of some new flows of capital, where cat bond fund managers are able to take in money more reactively, from commitments already made or where fund structures allow, that will help in soaking up some of the issuance.
But it seems this mismatch in particular is set to persist until the pipeline slows down, which would typically happen as we move into June and beyond.
Historically, the catastrophe bond market has been very good at managing appetites, versus activity, versus capital availability.
But, in 2022, with a range if external forces also at play, this has become more challenging than perhaps ever before, resulting in the spread widening perhaps being accentuated, while the supply-demand challenge has been extended due to the vigorous primary issuance flows.
As we wrote a few weeks ago:
With the pipeline still building, while appetites and available capacity from investors remain stretched, we could see the current spread widening sustained and perhaps not every new cat bond getting the execution its sponsor had hoped for.
That has now certainly come to pass, as evidenced by recent pricing increases across the majority of bonds, some restructuring and even the cancellation of some issues.
This is crystallising investor appetites around the long-term sponsors of cat bonds, or those with the best track-records when it comes to recent loss years, with these ceding companies likely the ones to secure the best execution in this market.
This differentiation, like we’ve seen in the traditional reinsurance market in recent years, is also serving to make some catastrophe bond fund managers more selective in how they deploy their capital.
With such a busy pipeline of deals and so many new catastrophe bonds still to be priced at this time, a lot of available capital will be soaked up in support of these, while new inflows may still be a bit more limited due to the external factors and investor appetites.
There are some maturities coming, which will provide cat bond fund managers with some additional capital to deploy.
But at somewhere around $2.3 billion of cat bonds set to mature by end of June, this may not be sufficient alone to rebuild some appetite for the new deal pipeline and the immediate capital needs won’t be met through this capacity recycling process.
Which means there could be some managers that find their appetite limited for new cat bond deals, due to a lack of available capital to buy as much of each as they would normally have liked to.
It’s important to note, this is a very healthy marketplace at this time, with buoyant issuance reflecting insurer and reinsurer appetite to tap the capital markets for protection in a fully-securitized manner, while investor appetite still remains high for cat bonds, despite all of the external factors.
But, recent market conditions may provide a glimpse of how technology will inevitably help to make cat bond issuance, marketing and sales a much smoother process in future (like other securitized markets), enabling investors to truly express their risk and capacity appetites and matching them to protection buyers needs.