Catastrophe Bond Update: Third Quarter 2010 – Activity (and Great Expectations) Persists, Part III: Market Dynamics
Third Quarter Market Dynamics
Spreads generally tightened during the third quarter, particularly after the mid-point of the U.S. hurricane season. Concerns over U.S. hurricane concentrations abated, while maturities and net new inflows continued. To date, the 2010 hurricane season, though quite active in terms of storm formation, has not produced land-falling storms causing significant insured losses within the United States. There is now a renewed focus on the fact that 40 percent of the existing catastrophe bond issuance will mature by the end of June of 2011. Notwithstanding this maturity schedule, catastrophe bond market participants are eager to demonstrate growth and sustained issuance throughout the reinsurance pricing cycle and are therefore eager to see additional new issuance. In the absence of a certain visible pipeline (though much market chatter about fourth and first quarter transactions persists) in the current secondary market cat bond buyers are generally outstripping sellers, prompting prices of existing bonds to appreciate.
Investors are currently focused on stimulating issuance in order to deploy cash inflows from the maturities of their existing catastrophe bond holdings (which will accelerate over the next nine months) as well as from new capital inflows. As yields are tightening across financial markets generally (discussed in greater detail below), some investors appear willing to accommodate lower yields as catastrophe bonds remain competitive on a relative value basis with alternative asset classes. There is now a sustained bid across all typical catastrophe bond market perils, with particularly strong appetite for transactions exposed to non-U.S. hurricane perils (e.g., European wind, Japan wind and earthquake, U.S. earthquake, and U.S. tornado and thunderstorm). The composition of 2010 issuance is the driver for these preferences, as the majority (81 percent) of 2010 issuance to date has included exposure to U.S. hurricane and over 60 percent of the total catastrophe bond market is now U.S. hurricane exposed. Because of the strong demand for additional issuance, investors are increasingly willing to consider longer dated transactions and aggregate covers. In addition, the current environment provides more flexibility to sponsors than has been the case in previous years on other structural features including: (i) trigger type (e.g. in 2010 year to date more than half of the risk capital raised has been triggered on an indemnity basis), (ii) covered perils and (iii) covered lines of business. The market does, however, remain disciplined with respect to modeling requirements and data quality in general.
Condition of Broader Capital Markets and Impact on ILS Market
Relative to the extreme conditions prevalent during the credit crisis of late 2008 and 2009, capital market conditions continue to improve. Confidence levels in the financial and banking system, as proxied by the decline in the spread between 3-month LIBOR and U.S. government borrowing rates, have increased dramatically.
Equity markets have also stabilized, and are now trading at volatility levels roughly consistent with long term averages. Concurrently, corporate credit yields have continued to tighten.
In the context of this improving stability, investors are once again interested in deploying capital into a generally non-correlated asset class relative to other capital market asset classes. The ILS market, which was among the best performing asset classes throughout the credit crisis, is well suited for capital markets investors, and has a performance track record reflecting its value and non-correlation.
• Chi Hum, Managing Director
• Cory Anger, Managing Director
• Hong Guo, Managing Director
• Ryan Clarke, Vice President
• Brad Livingston, Analyst
ILW Market commentary provided by
• Barry Law, Managing Director (Guy Carpenter London)
• David Rothestein, Vice President (Guy Carpenter London)
* Securities or investments, as applicable, are offered in the United States through GC Securities, a division of MMC Securities Corp., a US registered broker-dealer and member FINRA/SIPC. Main Office: 1166 Avenue of the Americas, New York, NY 10036. Phone: (212) 345-5000. Securities or investments, as applicable, are offered in the European Union by GC Securities, a division of MMC Securities (Europe) Ltd., which is authorized and regulated by the Financial Services Authority. Reinsurance products are placed through qualified affiliates of Guy Carpenter & Company, LLC. MMC Securities Corp., MMC Securities (Europe) Ltd. and Guy Carpenter & Company, LLC are affiliates owned by Marsh & McLennan Companies, Inc. This communication is not intended as an offer to sell or a solicitation of any offer to buy any security, financial instrument, reinsurance or insurance product.
Chi Hum, Cory Anger, Hong Guo, Ryan Clarke and Brad Livingston are registered representatives of MMC Securities Corp.