Cat Bonds in Second Quarter Slow Down: Report

Chris Westfall
Chris Westfall

The catastrophe bond market is treading water as issuers may sit on the sidelines as over $2.4 billion in securities are set to mature this quarter, according to a report released Wednesday by Aon/Benfield.

However, rather than abandon the market for other asset classes the report says that investors will double down on existing issues.

“As the primary market pipeline appears to be less active in Q2 2011 than it was the year prior, we expect downward pressure on ILS pricing as investors seek to reinvest the inflows from maturing bonds,” the report says.

The report explains that spreads on catastrophe bonds will remain “relatively stable” heading into the U.S. hurricane season and that “in the absence of any further significant global catastrophes” cat bond indexes should post strong performance for 2011.

The rosy assumption is being made following a poor quarter for catastrophe bond trading. The Aon/Benfield All Bond ILS Index posted a negative two percent return for the three months ending March 31, compared to a 3.4 percent return in the same period last year. The Aon/Benfield report adds that the BB-Rated ILS Bond Index posted a 3.2 percent loss for the first quarter of 2011 compared to 3.5 percent return for the same period in 2010

Aon/Benfield added that the U.S. Hurricane Bond and U.S. Earthquake Bond indices both posted gains for the first three months of the year, although it added that the performance of the U.S. Hurricane Bond index was assisted by coupon returns despite “slight” mark-to-market losses.

Catastrophe bonds suffered during the first quarter of 2011 as uncertainty in the asset class was driven by the March 11 earthquake in Japan. The report cites sever bond issues, including Montana Re Ltd.’s Class E, Topiary Capital Ltd.’s Series 2008-1, Muteki Ltd.’s Series 2008-1 Class A – that may be poised to suffer losses.  

“Several ILS investors exited positions exposed to Japan Earthquake until the extent of the damage could be better understood,” the report states. “The events in Japan also caused short term reduction in trading volumes of U.S.-based risks as investors focused on Japan. Interest around U.S. trading had begun to increase at press time.  

Another issue holding back the market in the first quarter was February announcement by Risk Management Solutions (RMS) of major update to its U.S. hurricane model. The change has resulted in a good deal of uncertainty in the catastrophe bond and reinsurance markets about its impact on exposures.

“While investors may regard the changes as justification for increased coupons, this potential impact has not yet been evident,” the report said in regards to the RMS announcement. “Sponsors may continue to delay issues while the market assesses the impact of the change. Additionally, secondary market pricing is still absorbing the model change. “