Diversifying Peril Issuance and Continued Net New Inflows Sustain Capital Markets as a Consistent Capacity Source; Significant Forward Pipeline Exists
The third quarter 2011 was one of the most active on record, as the catastrophe bond market responded to investor demand for additional investment opportunities, particularly for diversifying peril transactions. Three transactions totaling USD512 million were completed during the third quarter 2011, making it the third most active third quarter on record. Completed issuance contained no exposure to U.S. hurricane peril. Excluding quarters in which no cat bond issuance overall occurred, this is the first quarter since the third quarter 2002 in which there was no transfer of U.S. hurricane risk.
Issuance in the 144A market was supplemented by two transactions totaling USD172 million of risk capital placed via Section 4(2) private placements (1). Aggregating the 144A and 4(2) placement activity together, total issuance for third quarter 2011 amounted to five transactions of USD684 million of risk capital. Total risk capital outstanding increased by 0.56 percent (equivalent to USD60 million) during the third quarter, the first increase since the fourth quarter 2010 and the second quarterly increase in the last seven quarters.
Demand for additional catastrophe bond issuance remains robust. Continued volatility in the broader financial markets and comparatively attractive returns are sustaining net new inflows to the sector. In recent years, the fourth quarter has been extremely active for new issuance. With U.S. wind season losses less than pre-season estimates suggested, and diversifying issuance providing ballast to investor portfolios, it is likely that the fourth quarter 2011 will be active as well. At the conclusion of the third quarter, total 144A issuance for the 2011 calendar year stood at USD2.12 billion, which is below the 2010 three quarter mark of USD2.58 billion. There is, however, a substantial transaction pipeline both for the fourth quarter 2011 and into first half 2012. Depending on how much of the pipeline converts to actual transactions and when these transactions come to market, it is reasonable to expect total issuance for the year to fall between USD3.5 billion and USD4.5 billion.
Risk capital issued in the third quarter more than doubled from the third quarter 2010. Last year, two transactions resulted in USD232 million in risk capital issued, while this year, USD512 million of risk capital was issued through three transactions.
The first transaction to close during the third quarter 2011 was the USD150 million Queen Street III Ltd., on which GC Securities acted as sole bookrunner. This transaction provides sponsor Munich Re with multi-year fully collateralized protection for European windstorms and utilizes a PERILS-based trigger. Queen Street III Ltd. was the first European windstorm-only deal of the year and was significantly upsized in response to strong market demand. Embarcadero Re, providing reinsurance to the California Earthquake Authority (CEA), was the second transaction of the third quarter. The transaction was also supported by significant investor demand as the market was eager for California earthquake risk on a standalone basis and also eager to support a significant first time sponsor. Embarcadero Re was significantly oversubscribed and the market expects additional issuance from the CEA during the 2012 calendar year. The final 144A transaction of the third quarter was EUR150 million Pylon II Capital Limited (Pylon II). Pylon II, which provides protection for French windstorms on a parametric basis, marked the return to the catastrophe bond market by the corporate sponsor Electricité Réseau Distribution France (EDF), which last accessed the catastrophe bond market in 2003. Pylon II, which has a 4.75 year risk period, priced below the low end of its initial price guidance, benefiting from a clean transaction structure and strong demand for European wind risk on a standalone basis.
For the first three quarters of 2011, a total of 11 catastrophe bonds were issued, providing USD2.11 billion in risk capital. (2) Year-to-date issuance is down 18 percent relative to the USD2.56 billion issued during the first three quarters of 2010.
Catastrophe Bond Redemptions
In the third quarter 2011, USD400 million of risk capital matured comprising the USD200 million Fhu-Jin transaction, which was exposed to Japanese Typhoon risk, and the USD200 million Topiary Capital transaction, which was exposed to multiple perils on a second event basis. The maturity of these transactions strengthened the bid for non-first event exposed and non-U.S. wind transactions during the third quarter.
Risk Capital Outstanding
Total risk capital outstanding increased from the second to the third quarter 2011, reaching USD10.70 billion – up from USD10.64 billion, representing a net increase of 0.56 percent (USD60 million). This is the first quarter that risk capital outstanding increased since the fourth quarter 2010. The sector continues to sustain net new cash inflows and the first and second quarters 2011 included significant maturities of existing cat bonds. Consequently, the market is still seeking additional issuance. These factors should manifest as strong support for transactions coming to market during the fourth quarter 2011 and into the first quarter 2012.
Risk capital outstanding peaked at the end of 2007, at USD14.02 billion. It then fell to USD11.19 billion by the end of the first quarter 2009 and thereafter remained within a range of USD10.9 billion and USD12.5 billion before dropping to USD10.6 billion at the end of the second quarter 2011. Comparing the current pipeline with the modest (USD2.15 billion) amount of scheduled maturities prior to June 30, 2012, we expect that total risk capital outstanding should trend upwards, potentially significantly, over the balance of 2011 and during the 2012 calendar year.
 Section 4(2) private placements are typically marketed to a smaller investor group, do not require the provision of uniform disclosure information to all investors and tend to have more restrictions pertaining to resale in the secondary market relative to 144A placements.
 This figure only includes broadly distributed 144A catastrophe bond transactions.
• Chi Hum, Managing Director
• Cory Anger, Managing Director
• Hong Guo, Managing Director
• Ryan Clarke, Vice President
• Brad Livingston, Assistant Vice President
ILW Market commentary provided by
• Barry Law, Managing Director (Guy Carpenter London)
• David Rothestein, Vice President (Guy Carpenter London)
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* 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.