July saw activity in the secondary market for catastrophe bonds and insurance-linked securities slow down somewhat compared to the prior few months which had seen heightened activity and strong, if somewhat unseasonal price rises. The pattern displayed by price return indices of outstanding catastrophe bonds became much more stable, exhibiting more seasonally expected trends, but it was not just the U.S. hurricane season causing the slowdown in activity.
The primary cat bond and ILS market was where the truly unseasonal activity occurred in July, with three new transactions coming to market bringing $675m of new risk capital into the market. This is unusual for the time of year, although the bulk of the risk capital issued was of a diversifying nature. All of the transactions increased in size and all priced towards the lower end of expectations, both of these factors underlining the continuing high demand for the ILS asset class.
This supply of new risk capital into the sector exerted some pressure on secondary market prices, according to Swiss insurance-linked securities investment manager Plenum Investments. This pressure meant that price rises in July were not as pronounced as in previous months, although there was some positive price rises due to the quiet nature of the U.S. hurricane season thus far. Plenum said that mark-to-market gains were most pronounced on U.S. perils, with U.S. hurricane exposed bonds showing the largest price increases.
Trading volumes were moderate in the secondary market, according to Plenum, as most investors have already positioned their portfolios ready for the peak hurricane months, meaning that managers reallocation needs were not as prominent as in recent months. Plenum expects secondary market trading volumes will remain moderate with increases only being seen around any significant events affecting the market. Their fund saw a gain of 0.78% in the U.S. dollar class, down on June but considerably higher than last year. Plenum sees themselves as well positioned to take advantage of expected U.S. hurricane cat bond price rises as we move through the peak of the storm season.
ILS investment manager LGT Insurance-Linked Strategies noticed similar effects in the primary and secondary cat bond and ILS markets, according to their latest monthly managers commentary. On the primary market, they recognise that the $675m of issuance was “somewhat atypical” for this time of the year. The LGT ILS team said; “The current market is proving to be optimal for sponsors wishing to bring risks in securitised form.”
On the secondary market, LGT said that trading was fairly active and some managers were revisiting their portfolios to accommodate the newly issued cat bonds and ILS. Even with the unusual volume of new issuance, demand for cat bonds and ILS from investors remained strong in July. They said that investor appetite has not yet been satiated, particularly for non-U.S. risks, which suggests that LGT see sufficient demand for the market to accommodate further new issuances of diversifying perils were any sponsors feeling ready to bring new transactions to market.
LGT saw secondary market prices of most cat bond positions as fairly stable in July. They say that given the uneventful U.S. hurricane season (so far) hurricane-exposed bonds have shown only a little fluctuation in prices.
LGT have been active in July, investing in two of the new ILS issuances but declining the third as they didn’t feel the premium offered for the risk stacked up for their investment strategy. They have also been active on the secondary market, making a couple of purchases to further optimise their portfolio.
Interestingly LGT say that the current market conditions look conducive to encouraging primary issuance as we move further into 2012. Strong investor demand for ILS and cat bonds, which LGT see continuing through the year, has led to soft conditions in the cat bond market they say. Spreads for cat bond and ILS deals have been close to traditional reinsurance premiums, making the capital markets a very competitively priced source of risk transfer. LGT say that this trend should send a positive signal to potential sponsors of cat bonds and ILS who are price sensitive and the current market environment could help to increase issuance activity through the rest of the year.
That’s encouraging and is inline with the sentiment of other investment managers we have spoken to and a number of regular cat bond and ILS sponsors and re/insurers who have never sponsored a deal before.
Could market conditions (competitive issuance costs, high investor interest, capital on the sidelines) create a perfect storm for cat bond and ILS issuance towards the end of 2012? Right now it does seem like a continuation of the high levels of issuance seen recently is a possibility, but it is of course dependent on many factors, including how active and impactful the U.S. hurricane season is over the next couple of months.