There are some interesting insights into the catastrophe bond market contained within a recently published newsletter from Zurich, Switzerland based insurance-linked securities investment manager Twelve Capital. In their latest Twelve Perspectives report they look back at the cat bond market in the first-half of 2012, commenting on some of the features they have seen emerge in the market, and let us know how they feel about the market for the remainder of 2012.
The first-half of 2012 saw just over $3.6 billion of issuance, the second best first six months to the year that the insurance-linked securities and catastrophe bond market has ever experienced. Interestingly, Twelve Capital point out that the $3.6 billion actually began life as a notional volume of just $2.3 billion when the deals were first announced. So that means that the notional volume of the cat bond and ILS markets issuance increased by 56% during the first six months of the year. That’s an incredible statistic which really demonstrates the appetite that investors have for these assets and the amount of interest there has been in new transactions.
Also of interest is the fact that only one deal was downsized during marketing and also another deal was taken off the market completely after its initial marketing. That isn’t news, but what you may not be aware of is the fact that these two transactions both had expected losses above 6%, according to Twelve Capital. Those are particularly risky deals as evidenced in our recent articles which refer to the expected loss of the cat bond market and you can find here and here. Cat bonds with an expected loss above 6% are rare and perhaps this shows that even with high levels of investor appetite they are not willing to accept that level of risk in the structures in which it is currently offered to them. Further work on deal terms and structural innovations may be required to encourage investors to accept that sort of risk, or perhaps the cat bond and ILS market will never be the right place for deals that risky, time will tell.
Twelve Capital take a look at the expected loss and risk premium changes seen in cat bond issuance in the first-half of 2012 compared to the same period in 2011. The first-half of 2012 saw an average coupon of 10.1% compared to 8% in 2011, while expected losses in 2012 averaged 1.97% compared to 1.82% in 2011. This shows that the risk profile of deals coming to market was slightly higher and as a result investors were demanding, and being offered a higher risk premium coupon. That equals better risk adjusted returns in the 2012 issuance according to Twelve Capital. You can clearly see the better risk adjusted return profile of 2012 in the price analysis graph below.
Twelve Capital say that they expect to see another $3 billion of issuance in the second half of 2012 which will help the market to achieve $15 billion of notional volume outstanding by the year-end. The fact that the amount of issuance has already passed the amount of maturities due in 2012 means that every issuance from here to year-end will help the market grow larger. Of course upsizing of deals could increase that figure further, but even if that doesn’t happen, $6.6 billion would be a very positive outcome for the cat bond and ILS market at the end of 2012.
The newsletter notes that spreads have been much higher than last year in the first six months of 2012, but that has changed since Long Point Re III and also in the first deals of the third quarter. However Twelve Capital say that they remain positive and expect only a slight spread reduction in the coming months. Twelve Capital also say that they expect to see continued innovation in the market during the remainder of 2012 which would be positive for the market and will help to keep investor interest and appetite growing.