Catastrophe bond pricing floor expected to persist: GC Securities

GC Securities, the investment banking, catastrophe bond and capital markets arm of reinsurance broker Guy Carpenter, said today that it expects the catastrophe bond pricing floor, which was seen during the second-quarter, will persist for the near future.

“The pricing floor that was seen in the second quarter, particularly for lower expected loss catastrophe bond structures,” is a trend that GC Securities “expects to continue for the near future,” the broker unit said in its latest catastrophe bond market report.

The report, which looks at Q2 2015 issuance of cat bonds, explores the pricing dynamics of the cat bond market. In Q2, many cat bonds priced at mid-point of guidance or above, providing evidence that insurance-linked investors had reached the bottom of their risk appetite for certain layers of risk.

The “lower expected loss” cat bond structures are the more remote risk layers ceded to the capital markets. As such, investors have now reached a point where they are not prepared to go much lower on price in order to hold those risks for ceding insurance or reinsurance companies.

The same trend was also evidenced by activity in the secondary cat bond market, where pricing of outstanding 144a cat bonds has been on an upward trend, according to GC Securities.

“As of June 30, 2105,” GC Securities notes, “Secondary pricing was sitting above the 2015 initial issuance trend curve.”

This suggests that “investors are demanding a higher spread than the primary issuance spread in order to facilitate a trade in the secondary market,” again providing evidence that a floor in risk appetite and pricing has been reached.

But appetite has not waned, according to GC Securities. There is evidence that investors are now seeking greater access to diversifying perils, or to lower layers of risk where the returns from cat bonds would be better, due to higher risk of attachment.

“We continue to see high demand among ILS investors for non-traditional diversifying exposures, which has encouraged new sponsors to evaluate alternative capital for protection in new regions not currently accessing the alternative capital and catastrophe bond markets,” commented Cory Anger, Global Head of ILS Structuring, GC Securities.

However, the search for better returns in the cat bond market is destined to leave some of the more remote layers facing less investor demand.

“The reach for yield, even within the catastrophe bond asset class, has resulted in some investors reducing allocations to lower than expected loss deals,” GC Securities said.

But the hope is that this encourages more issuance of higher risk layers, diversifying perils, or different structures, which compensate ILS investors better for the risks they are taking on.

GC Securities explained; “This should encourage sponsors to cede less remote risks to the capital markets where a pricing floor is not yet definitive.”

That is just what the cat bond market needs, to boost its overall return. In the past cat bond average coupons sat around the 6% to 8% range, compared to the 2% to 4% we have seen of late. ILS investors would welcome a chance to access more higher-yielding cat bond business, particularly at this time when the global financial markets are so uncertain.

There is a strong chance that sponsors of cat bonds looking for coverage for lower layers of reinsurance or retrocession programs would find their issuances well-received by investors, resulting in attractive pricing for risks that allow investors to move their returns above the now established cat bond pricing floor.