Hurricane Delta to hit Cat 3+, threaten Mexico’s FONDEN 2020 cat bond

Tropical storm Delta has quickly intensified to become Category 2 hurricane Delta as it moves through the Caribbean and the hurricane is now expected to reach major status, of Category 3 or higher, as it moves towards a landfall on the central U.S. Gulf Coast at the end of this week.

Hurricane Delta became the fastest 25th named storm of any season to form yesterday and has now become the 9th hurricane of the particularly active 2020 Atlantic tropical storm and hurricane season.

Update: Hurricane Delta reached Category 4 strength with 130mph+ winds before the end of the day.

On course for a United States landfall sometime on Friday into the early hours of Saturday, now hurricane Delta has put the insurance, reinsurance and insurance-linked securities (ILS) communities back on alert after a short lull in tropical activity over the last week to ten days.

Having intensified rapidly overnight, hurricane Delta is now packing sustained winds of 110 mph with gusts of over 125 mph as it moves steadily northwest through the Caribbean.

The Cayman Islands are likely to escape the worst of hurricane Delta, as the centre passes to the west of the islands today, but currently the tip of the Yucatan Peninsula, Mexico is forecast to receive a hit as hurricane Delta travels generally north west towards the Gulf of Mexico.

Before hurricane Delta reaches the Yucatan it is expected to have intensified further to major Category 3 or stronger hurricane status, so the threat to that region of Mexico may be severe.

Depending on the intensity of Delta as it approaches the Mexican coastline tomorrow, there is the potential for the World Bank’s IBRD issued IBRD / FONDEN 2020 catastrophe bond transaction, that provides disaster insurance and reinsurance to Mexico’s Government’s FONDEN catastrophe fund, to come into focus.

The catastrophe bond was issued earlier this year in Q1 and was hailed as an important part of Mexico’s social protection strategy.

In order for that parametric catastrophe bond to be at-risk, the minimum central pressure of hurricane Delta would need to dip down to around 930mb to 940mb it appears.

Currently hurricane Delta has a minimum central pressure of 962mb, and further deepening is expected as the storm intensifies towards major hurricane status, meaning that the FONDEN cat bond will likely come under some scrutiny from cat bond funds and investors today.

The FONDEN 2020 catastrophe bond has a stepped parametric payout structure, with 25%, 50% and 100% payouts of principal possible.

The $125 million tranche of Class C notes are exposed to hurricanes on the Atlantic side, where hurricane Delta is situated.

For this catastrophe bond to be triggered it needs the minimum central pressure of hurricane Delta to dip below predefined levels as it breaks a parametric box drawn around the eastern coastline of Mexico. The Yucatan Peninsula is right in the middle of the box and from the information we have it appears a decline in pressure to around 935 mb or lower could threaten the notes with a 25% loss of principle.

It’s difficult to tell for certain, as we do not have the precise structure details of the parametric trigger available to us. But it is safe to say that if hurricane Delta strengthens significantly and its minimum central pressure falls to around that sort of level, cat bond funds and investors holding the FONDEN 2020 Class C notes will be on high-alert.

The FONDEN 2020 catastrophe bond is designed to support the Mexican Government’s need for post-disaster capital inflows, with the insurance and reinsurance capacity backing the deal sourced from the capital markets to augment FONDEN’s own capital base.

Aside from that potentially exposed catastrophe bond, the Yucatan Peninsula area and regions such as Cozumel and Cancun are in the path of hurricane Delta, putting high-value tourism assets and hotels at some risk.

There is insurance and reinsurance capital exposed to hurricane Delta’s expected passage over the tip of the Yucatan and we understand there are some parametric corporate insurance contracts in place with resorts in the region as well.

But the bulk of the insurance, reinsurance and ILS market will be watching for how hurricane Delta reacts to its interaction and possible landfall on the Yucatan and how well it maintains its structure as it heads into the Gulf of Mexico, where it could remain a strong hurricane as it tracks towards the U.S. coastline.

The image below from Tropical Tidbits showing modelled forecast guidance on the intensity of hurricane Delta is still mixed, suggesting hurricane Delta could weaken before it reaches the Gulf Coast, but some models suggesting it may sustain major status. As a result a stronger landfalling hurricane cannot be ruled out at this stage and we’ll need to see how Delta looks after it has emerged back over the Gulf of Mexico late on Wednesday, into Thursday..

As well as threatening strong winds that may cause property damage to the Yucatan Peninsula region, hurricane Delta is also expected to bring around 10 inches of rainfall with it and could cause landslides and flash flooding, while storm surge levels of 6 to 9 feet are expected.

If hurricane Delta continues to rapidly intensify it could be a very dangerous storm by the time it reaches the Mexican coastline, putting lives at risk as well potentially as the FONDEN cat bond.

Once past the Yucatan the focus will be on the Gulf Coast, as the forecast track continues to put hurricane Delta ashore as a hurricane in Louisiana by the end of this week. We’ll keep you updated.

Track the 2020 Atlantic tropical storm and hurricane season with our dedicated page.