Catastrophe bond market continues to trade, as loss clarity emerges

The catastrophe bond market has continued to trade through the recent losses, with activity in the secondary market relatively brisk in October 2017 and signs beginning to emerge that pricing uncertainty is gradually coming off, which combined with new issuance should help to stimulate more liquidity over the coming months.

Following the impacts of major hurricanes Harvey, Irma and Maria, as well as the California wildfire, many catastrophe bond names have been threatened, or seen to be at risk of some level of loss, but the volatility in their secondary pricing marks is slowly diminishing, as it becomes clearer which cat bonds are likely to face a loss and which may make a price recovery.

The cat bond market saw a relatively high level of trading for an October, which can tend to be a quieter months being still in the hurricane season.

FINRA’s Trade Reporting and Compliance Engine (Trace) recorded at least 43 individual cat bond names that traded during the month of October, with some trading a number of times each. But the actual number will have been a good deal higher as at least one broking desk does not report the majority of its trades through the system.

Investors have reported that the emergence of more accurate insurance and reinsurance loss estimates for the hurricane events and California wildfires is helping to foster more liquidity, as the clarity over the potential for losses to cat bonds increases and confidence returns in the secondary marks for certain cat bond names.

As the size of recent catastrophe losses becomes clearer and the gross losses of affected insurance and reinsurance firms gets reported, the cat bond market can begin to put a better estimate on the mark-to-market impact to specific names.

With third-quarter reporting season now all but done for insurance and reinsurance firms that have sponsored catastrophe bonds, a much better picture has now emerged of which cat bonds are truly at risk.

The cat bond broking desk pricing sheets are all showing fewer bonds marked down with each passing week, as this clarity continues to improve and the gulf between bid and offer pricing has narrowed considerably, reflecting lower price volatility in market pricing and greater certainty in where losses will emerge among the indemnity cat bond cohort.

As the estimates have come in, cat bond fund managers and investors have traded on the back of improving loss estimates, as well as putting to work any additional capital they have available to them.

One thing that hasn’t been seen as frequently as you might have imagined, is cat bond investors trading out of potentially loss exposed positions.

This could be down to the uncertainty and volatility in pricing, with bid and offer spreads wide and so true mark-to-market impact not always easy to derive.

As the clarity emerges over recent losses, we could see more of this type of trading activity, as investors may look to either limit their exposure of take whatever prices they can get on positions where there is still the potential for losses to emerge.

This process, of gaining a better understanding and clarity of potential cat bond losses, is likely to result in greater liquidity going forwards, as the market will trade more healthily as the number of cat bonds thought exposed reduces.

It will be interesting to watch how new issuance affects secondary cat bond trading, as there is the potential for some new issues to have higher risk adjusted pricing than existing marks and we could see some portfolio rebalancing as investors look to provide space in their portfolios for better returning cat bond names.

Join us in New York in February 2018 for our next ILS conference