The first quarter of 2012 was dominated by a significant amount of activity in both the primary and secondary markets. The primary market showed signs of market firming despite a record level of issuance being completed. Transactions for which modeling uncertainty was more meaningful or that addressed perils already significantly represented in the market, in some instances faced more challenging marketing environments. From a structural perspective, investors and sponsors continued to demonstrate an interest and willingness to update structural features of transactions. In light of recent transactions, changes were made to further ensure that in a post-event loss scenario all stakeholders in the transaction are provided an ability to efficiently express their views in the instances in which judgment is required. Transparency also continued to increase as multiple sponsors elected to include company loss files (CLFs) as a supplement to the transaction offering materials. These enhancements both in spirit and practical impact are important indicators of the market’s continued advancement.
In the secondary market, bond sellers generally outstripped bond buyers. Selling interest was dominated by a small number of investors seeking to liquidate relatively large portfolios. Notably, the market demonstrated ample liquidity as these offers were sold promptly and at a modest discount given the size transacted. Smaller sellers also sought to exit positions in order to participate in a more meaningful size in the primary issuance market. On a total return basis, performance across the ILS market was flat for the first quarter of 2012 as increased risk spreads on new issuance were offset by mark to market price reductions on outstanding issuance.
This market continues to play an increasingly important role in the overall risk transfer decision process for protection buyers. Though transactions in some instances contended with greater discussion with respect to price, in general these discussions were within reasonable ranges. More than sufficient capacity was available to support all deals that came to market during the quarter for transactions that were priced to reflect market conditions.
The composition of the capacity continues to expand. Dedicated ILS investors continue to serve as anchor orders for most transactions. These larger dedicated investors with longer track records continue to report net inflows and are having continued active conversations with new prospective accounts. Additionally, smaller dedicated managers are also growing and increasing their participations. During the first quarter there was a return of multi-strategy investors and in some cases more aggressive hedge fund capital, to certain transactions. The participation of hedge fund capital in 2012 transactions, while notable, may be more a function of the high yielding opportunities, several of which carried annual risk spreads in excess of 10 percent. Interest also continues to increase amongst non-dedicated/non-hedge fund investors including pension and sovereign wealth funds, life insurance companies and traditional long-only oriented asset managers. Some of these investors are new to the market while others have been smaller participants in the space for several years. They have built up a track record and a comfort level which now allows them to increase their exposure to the asset class through larger participations on transactions that fit their investment parameters.
Looking ahead to the balance of 2012, there is the potential for a record year for primary issuance, which would imply a total for the year in excess of USD7.0 billion. Converting this potential into reality, however, will be dependent on catastrophe activity, traditional market conditions and market interest (and overlapping price versus value ranges) from both protection buyers and sellers. GC Securities’ current baseline view is issuance in the area of USD5.5 billion, with significant potential for more issuance, subject to market conditions.
* 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.