One of the interesting features of the catastrophe bond market in 2013 was the trend earlier this year that saw secondary cat bond market prices rise through February, March and April. This was triggered at first by lower than expected first-quarter cat bond issuance but spreads continued to tighten right up to May, helping catastrophe bond investors achieve attractive returns.
This somewhat unseasonal price movement on many outstanding cat bonds resulted in pricing on some deals moving to above par at a time of year when this would typically not have been expected. The lack of supply in Q1 turned into a bumper period of issuance in Q2 but with the increase in capital interest and number of investors in ILS and cat bonds, the activity in the secondary market increased which helped push some prices even higher due to competition for outstanding bonds needed for investors portfolio rebalancing.
We even saw U.S. wind exposed catastrophe bonds pricing above par as the hurricane season approached, with the typical seasonal spread widening taking much longer to kick in than in previous years. We also saw a cat bond, Everglades Re, close with pricing almost 40% lower than the equivalent deal a year earlier, but within a day or two the notes were priced above par on the secondary cat bond market, demonstrating the robust investor demand for new issuances and secondary marks.
Now, we’ve moved into a period of more seasonal price return declines and activity in the secondary cat bond market has become more balanced, but it has become apparent that a number of investors have used this years primary and secondary cat bond market trends to capitalise and profit by offloading positions in certain deals.
Some investors have found recent pricing on new cat bond deals to be below their investment return targets, however they have also seen some cat bonds price above par soon after launch. This has enabled investors to do two things. First, we’ve heard of investors buying into new transactions and then offloading their positions in the secondary market soon after for a small mark-to-market profit as the notes priced above par.
Secondly, we’ve also heard of investors offloading longer held secondary cat bond positions, as the outstanding notes priced above par enabling them to sell them on for a profit rather than holding the notes for the return. These investors have typically reinvested in recent new cat bond issuances, or invested the capital back into collateralized reinsurance contracts which had a better return.
This type of activity has not been typical in the cat bond secondary market to date. Trading can be very light and has historically revolved around portfolio rebalancing needs, as investors make room to accommodate new deals or pick up secondary cat bond notes for diversification purposes. It is perhaps yet another sign of the increasing profile of the cat bond and ILS market that we are now beginning to see some signs of increased liquidity and speculative trading.
One investor which has profited from offloading secondary cat bond positions to capitalise on price gains has been Credit Suisse. In a recent fund managers report on its CS Iris insurance-linked security fund, Credit Suisse said that it had strategically chosen to move out of some cat bonds to profit from mark-to-market gains. This was also timed so that the resulting freed up capital could be invested in renewal contracts at the end of May which had a better return, something Credit Suisse said it would do as it looked for better performing assets for the Iris fund.
Credit Suisse said that May was an active month in terms of cat bond trading for its fund. It strategically sold a number of cat bond positions in order to “Lock in mark-to-market gains”, it said. Credit Suisse timed these sales so that it could immediately invest the capital back into top-layer U.S. wind reinsurance program renewals, were it finds the risk adjusted pricing relatively more attractive at the moment.
This kind of profit taking on secondary cat bonds is another slightly unusual feature of the 2013 cat bond market, with the dynamic of the ILS market making this possible and enabling investors to capitalise on the unseasonal gains in secondary cat bond prices. As the cat bond market, and activity in ILS and reinsurance-linked investing, continues to grow we expect that the opportunity to profit from offloading secondary positions will present itself more regularly.