Fitch: Pulling of Latest Cat Bond Deal May Signal Pricing Floor
CHICAGO--(BUSINESS WIRE)--In a signal of investor restraint due to less favorable price-to-risk terms, Munich Reinsurance Group (Munich Re) announced last week that it had withdrawn its latest catastrophe bond issuance (Queen Street X, Ltd.) due to weak demand. Pushback on the deal's pricing could be a sign that investors are approaching a limit on acceptable catastrophe risks, according to Fitch Ratings.
Thus far in 2014, cat bond investors have been willing to accept higher levels of risk at lower risk premiums, which have still been viewed as attractive compared to other asset classes, given their diversification benefits relative to traditional investment market risks.
Ratios of risk premiums to expected loss have fallen dramatically in the catastrophe bond market over the past several years as investor demand has greatly exceeded the available supply. The decline has been evident in the series of Queen Street transactions, as the last four issuances have seen a continuous drop to 2.02x for Queen Street IX from 4.72x for Queen Street VI (issued in 2012). Although the perils were different, the underlying expected loss remained relatively constant at 2.7%, while the risk premium declined to 5.50% from 10.35%.
If Queen Street X had been placed at the lower end a price range between 4.75% and 5.50%, it would have been one of the first bonds for which the risk premium/expected loss ratio would have fallen below 2.0x.
Through first-half 2014, nearly two dozen catastrophe bonds with varying risk levels were issued globally with an average risk premium of approximately 4.3%. This compares to the same period of 2013, which experienced an average of 5.7%. Of the bonds issued in 2014, four individual tranches were issued at a risk premium to expected-loss multiple of less than 3.0x. They include Residential Reinsurance 2014, Ltd. (Class 10 Tranche: 15% risk premium), Queen Street IX Re, Ltd. (5.5%), Lion I Re, Ltd. (2.25%), and Kilimanjaro Re, Ltd. (Class A: 4.75%).
The Residential Reinsurance 2014, Ltd. deal sponsored by USAA Group included an $80 million tranche with a premium/expected loss ratio of 1.52x but also included one of the largest risk premiums the market has seen in recent years at 15%, exemplifying the increased risk that investors have been willing to accept for deals that include significant risk premiums. Everglades Re, Ltd. 2014, and its record issuance size of $1.5 billion, offered the second-largest coupon rate of any bond issued in 2014 at 7.5% and a risk premium/expected loss ratio of 3.26x.
As the hurricane season runs from June to November, Fitch believes that the catastrophe bond market will see less U.S. named-storm peril issuance coming to market for the next couple of months. Other perils are expected to continue to be issued at relatively low risk premium/expected loss multiples throughout the year. As the market approaches a floor for cat bond pricing, the risk premiums paid to investors will be an important factor in determining the demand for cat bond transactions.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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