The cat bond new issues market may have disappointed last year. But don’t give up on cats yet, writes David Sandham
In February, the ice was broken on a frosted-over cat bond market by the issue of a $200m bond called Atlas Reinsurance V. It was issued by SCOR via Deutsche Bank and BNP Paribas. The bond was notable for its tight collateral structure. The collateral may be invested only in a defined list of secure assets, such as government bonds. It is likely that future cat bonds new issues will also be designed so as to withstand events such as the Lehman bankruptcy. Two further cat bonds, of $150m for Chubb, and $200m for Liberty Mutual, were being marketed.
Atlas Reinsurance V was the first cat bond new issue since August 2008. In contrast to 2007, which was a record year for cat bond new issues, 2008 was a disappointing year (see chart on right below). In 2007, there was a record $7bn of newly issued cat bonds. In 2008, there were only $2.7bn, this amount all being achieved in the first half of year. In the second half of the year, the market was closed.
As for the year ahead, few industry observers would venture to stick their necks out and make a prediction for the amount of new cats to be issued in 2009. Not least because last year most got it wrong. Last summer many expected that for the full year 2008 about $5bn of new cat bonds would be issued, instead of the actual $2.7bn. If a prediction must be made for 2009, then it looks like being a similar amount to 2008.
What went wrong in the second half of 2008?
And does the shortfall mean that there is roughly $2.2bn ($5bn minus $2.7bn) of cat bonds waiting in the wings?
A crucial factor is the secondary market for cat bonds. Last year some deals were “attempted but not fully launched” says Luca Albertini, CEO of Leadenhall Capital Partners, because of weakness in the secondary market, from which a number of troubled non specialised investors liquidated their cat bond positions. These investors were troubled, let it be said, by the general financial crisis, not by cat bonds. Indeed, for many who sold off their cat bonds, these were some of the best-performing assets in their portfolios.
Will the secondary cat bond market bounce back?
This will depend on general improvement in the economy, but also on sector-specific factors, such as redemptions. Over $1bn of cat bonds have been redeemed since December 2008; and more redemptions are due. Redemptions mean that more money is available to investors, which could lead to an improvement in the secondary market.
Another factor is the effect of the Lehman bankruptcy last September. Willow Re Series 2007-1, a cat bond for which Lehman was guaranteeing interest payment, recently defaulted. However, only four cat bonds have been directly affected out of more than 100.
Cat bonds offer good uncorrelated risk and have outperformed both equity and high yield corporate bond markets, as the chart on the left below, calculated by Swiss Re Capital Markets, shows.
David Sandham is Editor of Global Reinsurance