SIFMA Conference: Cat Bond Secondary Market Ballooned with Sellers

Chris Westfall
Chris Westfall

The secondary market for catastrophe bonds saw record activity over the last three months as the result of forced selling, but industry observers say levels have returned to normal this month.

Over $2.3 billion in catastrophe bonds traded in the secondary market in 2008, marking the first time secondary trading volume was higher than the primary issuance market, according to Al Selius, managing director at Swiss Re.

Cat bond traders made their comments at the Securities and Financial Markets Association’s Insurance and Risk Linked Securities conference last week.

Selius said that a number of factors produced record levels in secondary trading, but macro hedge funds looking to liquidate in the latter part of the year were the primary contributor to the volume spikes.

“There was some regular portfolio rebalancing at the beginning of the year, but then stress in the credit markets caused some significant selling in the latter part of 2008,” Selius explained. “There were a lot of redemption requests and people needed to raise cash quickly.”

Swiss Re estimates that secondary trading in catastrophe bonds was up 13 percent between 2007 and 2008.

Everyone attempting to get through the door quickly resulted in some “distressed” prices in cat bonds, with some issues trading at around 90 cents on the dollar.

“Compared to distressed asset backed trading it was very positive,” Selius said. “Also, the bonds traded on a dollar price basis and not on a spread basis, so it was more of a game to get out of the position and get that liquidity.”

Selius added that trading levels have returned to normal this month and he expects new cash will enter the market shortly.

“Quite a bit of bonds have matured, and quite a of bit of bonds will mature in May and June. So hopefully we can see new money put to work,” Selius said.

Although the secondary market has picked up, traders don’t expect arbitrage firms to move into position anytime soon, said Gerald Ouderkirk, managing director with Goldman Sachs & Co.

Ouderkirk explained that cat bonds are structured toward a buy and hold strategy since pricing the spread against other risks would be difficult for arbitragers.

“When pricing the insurance piece of the risk, there is no exact science and no mechanical way to say this deal in Northeast wind risk has to trade at this number of basis points,” he said.