After an April which saw supply and demand for catastrophe bond and insurance-linked securities (ILS) paper become more balanced, the very strong primary issuance in May resulted in low secondary trading and the first negative month for pricing this year.
The inexorable rise in secondary market catastrophe bond and ILS marks came to an abrupt end in May, as the bumper primary issuance (we recorded $3.19 billion in the Deal Directory) took the focus off the secondary market and ILS investors sought to put capital to work in new deals.
Craig Bonder, Managing Director and Head of ILS Trading at AK Capital, commented on the month of May; “The markets first negative month in recent memory is clearly the headline story this month of May. We questioned last month the possibility of prices finally dropping with prices being weighed down by the influx of supply, the previous strong run up in prices, and seasonality factors and it appears this was the case.”
With such a large volume of new risk capital coming to market, ILS managers and investors got a chance to put excess capital to work as well as, in some cases, to take on new capital to soak up the issuance. The requirement to balance portfolios was not as urgent in May, due to a wide range of perils coming to market, with time put into analysing and allocating capital to new deals instead.
Swiss based specialist ILS investment manager Plenum Investments noted the diversity available in May’s cat bond issuance; “The risks being brought to the market were very diverse, including US hurricane and earthquake, Japan typhoon, Japan earthquake, US winter storm and US severe thunderstorm.”
Plenum also noted the price declines, an unusual feature of the market after months of rising secondary marks; “The strong supply of new bonds in the primary market has affected secondary market trading. The solid demand for CAT bonds diminished somewhat which resulted in price declines across the board.”
Bonder from AK Capital gave some more colour on the secondary market conditions he saw at his busy ILS trading desk; “This supply allowed investors to not have to go into the secondary markets to source paper and build their portfolios. This reduction in demand along with many market participants busy with 6/1 renewals saw some credits lacking the strong bids we had grown accustomed to when credits were put out for sale. That being said certain credits were still in high demand and traded quickly as the market began to differentiate amongst assets more than in the past.”
It would be interesting to know what impact the decline on secondary pricing may have on the value of some ILS managers cat bond portfolios, once the latest pricing is factored in. Many managers have been benefiting from price appreciation and this turn to negative could make a mark-to-market dent on some positions, resulting in a negative return for the month.
Some price correction was always inevitable, as what goes up must eventually come down. Should the decline in secondary pricing continue, it might result in a more attractive asset for some newer investors who have struggled to get into the market due to the above par secondary prices.
Plenum details the price declines it saw, by peril; “Prices on US Hurricane bonds decreased by an average 0.8%, prices on US earthquake, Japan typhoon and Japan earthquake positions decreased by about 0.2%, Europe winter storm positions decreased on average by 0.4% while Europe earthquake bonds remained flat.”
Plenum notes however, that any decline is likely to be short-lived as with the hurricane season upon us secondary marks are likely to rise with seasonality. This should help managers recover any mark-to-market impact felt in May.
“It is worth noting that although this was a down month the market overall is still fairly strong and well up since year end. So all in all despite the negative total return one could view this as a strong and healthy month for the market as total market outstanding’s topped well over $20 billion.,” explained Bonder.
“Will this price slide be a mere temporary blip or will prices continue to fall for some time going forward? That remains to be seen but what does seem likely is that the very high dollar price premiums we have seen in the past for US wind quite possibly will not be seen for some time again,” Bonder continued.
The secondary market in ILS and catastrophe bonds is a good reflection of what is happening in the market. It reflects primary issuance, new capital inflows, ILS manager confidence, the level of diversification available and seasonal factors. Recent months have shown just how tight the correlation between issuance, new capital inflow and secondary trading levels are. A sign of a healthy market with increasing liquidity perhaps?