After the big decline in secondary market catastrophe bond prices seen in the week after hurricane Sandy made landfall we thought it would be good to catch up on the Swiss Re Cat Bond Performance Indices again to see how the last seven days had affected them. As the impact of Sandy on exposed catastrophe bonds begins to become clearer the indices have both recovered a small amount of the mark-to-market price declines and we expect the recovery to continue as prices of unaffected cat bonds rebound.
As with any major catastrophe, the days following the event are full of uncertainty as to how serious a loss it could cause the insurance and reinsurance industry. Sandy has been no different and in fact uncertainty from Sandy has been particularly high. Now, the secondary cat bond market has settled somewhat, with prices stabilised and some bonds which were potentially at risk, but now are known to be safe, recovering a little. A number of cat bonds will suffer an erosion of their subordinate aggregation layer (such as two Residential Re deals and Combine Re) as losses from Sandy eat into the protection that it affords to investors, but now these bonds are likely to recover some of the initial price declines as well.
Principal losses seem unlikely on most cat bonds, although there is still some concern about a number of transactions and investors and investment managers are nervously waiting to hear estimates on the losses from sponsors and the final industry loss estimate. In particular, Chubb’s East Lane Re IV is making some investors nervous, as Chubb writes much more flood coverage into its policies than do comparable primary insurers, therefore making exposure to Sandy losses potentially much larger. Chubb has said that tallying their losses will take more time but the firm stopped their share buyback program while the assessment continues.
Another tranche of cat bond notes that is getting a lot of attention, has seen price declines since Sandy and is considered potentially at risk is Swiss Re’s Successor X Class V – F4 notes. These Successor notes were unrated so details are more scarce. They use an industry loss trigger so their fate won’t be known until a PCS estimate is released. This tranche of Successor notes are priced well below par at the moment. There are other cat bonds which we’re told may see losses from hurricane Sandy reaching 75% or more towards their attachment points, but whether any will be triggered is still impossible to say.
So while there is still considerable uncertainty over whether certain cat bonds could face losses from Sandy, the market has stabilised and this allowed the cat bond indices to recover a small amount of their loss from the week before. With the potentially affected cat bonds already priced below par and other bonds now in the clear, there should be more recovery to come this week. Of course, if it transpires that any cat bond has suffered a principal loss that could adversely affect the indices again.
So, first we look at the Swiss Re Global Cat Bond Performance Price Return index, which tracks the price return for all outstanding USD denominated cat bonds (which you can quote and chart through Bloomberg here). A week ago this index stood at 93.17, a fall of 2.6% in a week. Now, at its latest close on the 9th November the index had recovered a little to close at 93.31. We expect that this index will bounce back further over the next week as the number of cat bonds facing potential losses is now a lot fewer than a week ago.
Secondly we turn to the Swiss Re Global Cat Bond Performance Total Return index, tracking the total return of a basket of natural catastrophe bonds (which you can quote and chart through Bloomberg here). This index has also rebounded a little from the 233.67, a decline in a week of 2.5%, that it sat at last Monday. Now, at the latest close on the 9th November, this index has recovered a little of the loss to finish at 234.43. Again, we expect this index to recover further over the next week now that the number of cat bonds at risk has shrunk somewhat.
Sandy is certainly going to subdue the October returns of most ILS funds, many will report a negative for the month, but it looks as if November may be better as some of the mark-to-market losses will be recovered over the coming weeks. For investors, any further impact from Sandy will likely be limited to any bonds which do suffer a principal loss or any knock-on effect an announcement of a loss of principal has on the wider secondary market.
We’ll keep you updated on the movement of these indices over the coming weeks.