Cat bond market more balanced, as spread widening slows

The catastrophe bond market, which has experienced a prolonged period of spread widening through much of the second-quarter, is now seemingly becoming more balanced, as a greater equilibrium between supply and demand is found, resulting in more attractive execution for four recent cat bond sponsors.

Through most of the second-quarter of 2022, catastrophe bond spreads have been widening out and new cat bond issues have priced at multiples not seen for around a decade.

Artemis’ measure of the average spread between expected losses and coupons at issuance of new catastrophe bonds has now reached its widest since 2012.

At the same time, Artemis’ measure of multiples at market of newly issued cat bonds is at its highest since 2013.

As we’ve been documenting, cat bond spreads began widening in earnest in early April, with a supply-demand mismatch as well as investor risk aversion driving this trend.

The effects of the spread widening may be felt through the rest of the year and with reinsurance rates for catastrophe exposures having hardened considerably it seems unlikely spreads will fall back to where they sat last year any time soon.

But now there is some early evidence that spread widening has slowed down and may even have been halted, with a number of factors responsible.

The evidence is seen in the four most recent catastrophe bond issues, as pricing settled within and even below guidance, or guidance was adjusted down in one case yet to price, with deals still upsizing to larger amounts than their initial targets.

First, Swiss Re’s recent Matterhorn Re Ltd. (Series 2022-2) cat bond, which grew in size and priced below guidance, indicating strong execution for the sponsor.

That was followed by Everest Re’s latest Kilimanjaro III Re Ltd. (Series 2022-1) catastrophe bond, which has also increased in size, while pricing at the mid-point of guidance.

Then, the Commonwealth Re Ltd. (Series 2022-1) catastrophe bond from first-time sponsor The Hanover, which again grew in size, but priced at the bottom end of its initial guidance.

Finally, as we explained earlier this morning, AXIS Capital’s new Northshore Re II Ltd. (Series 2022-1) catastrophe bond has upped its target size, while its price guidance has fallen.

Prior to these four cat bonds, new issues in May and before in April had largely priced at, or in some cases far above, their initial price guidance, while a number of cat bond deals had also failed to secure their targeted coverage sizes.

Which was really no surprise given the way reinsurance rates were also seen to move, while at the same time the wider capital markets have driven many investors to hold back on allocations at that time.

One factor that has been in play here, was the fact many of the largest catastrophe bond funds had seen their managers raising new capital in late 2021 and very early 2022, much of which additional capacity had been fully-deployed by the time the second-quarter pipeline exploded into life.

That has left minimal cash available at cat bond fund managers, at a time when securing fresh investor commitments has been particularly challenging, due to macro conditions, and maturities have not been sufficient alone to support all new deal issuances.

Risk aversion and the discipline of cat bond fund managers cannot be downplayed though, as many have backed away from some sponsors and layers of risk, while enforcing stricter terms and higher attachments, as well as the continued shift to event deductibles rather than franchise.

So alongside a supply-demand mismatch, there has also been a risk appetite mismatch with some sponsors ambitions for cat bonc coverage, which has driven spreads to widen further and made some executions particularly hard going for broker-dealers to secure for their sponsor clients.

That even resulted in some deals being pulled, but in the main the cat bond market has traded through this period extremely well, with most sponsors getting satisfied and a steady flow of new sponsors demonstrating the value of catastrophe bond backed reinsurance and retrocession, even at the higher spread levels.

Sources tell us that there has been a little new capital injected into some cat bond funds in very recent weeks, which may have gone some way to helping to slow the spread widening.

The evidence from the four latest issuances that priced, or look set to, attractively for their sponsors, while also upsizing, perhaps suggests the spread widening has now come to a halt.

But of course, the seasonal slowdown in issuance when the US wind season begins and the reinsurance renewals are upon us, may also have been a factor in helping the cat bond market find a better equilibrium of supply of capital and demand for protection this month.

It should be noted, that there is no way of knowing whether the spread widening has completely come to a halt for all sponsors yet, as given the slowdown in issuance the sample of deals available are not really sufficient to make that assessment.

But, the evidence from recently priced cat bond deals, plus the reports from our sources that a little new money has been raised into the cat bond space, all point to a more balanced marketplace for catastrophe bond issuance right now.

Timing of the market is sometimes key and while it’s not clear whether sponsors like Swiss Re, Everest Re, The Hanover and AXIS Capital have timed it on purpose, the fact there has been some fresh capital available, just at the point where the pipeline has become emptier, has definitely helped to soften the spread widening, resulting in an opportunity to secure very attractive market execution, we’d suggest.

Looking ahead, there are only two more new catastrophe bond issues in the market and yet to be priced, with both deal’s pricing due later this week.

It will be interesting to see how these two cat bonds, the Finca Re Ltd. (Series 2022-1) cat bond from Canopius and the aforementioned Northshore Re II Ltd. (Series 2022-1) from AXIS, will execute and how they price and size may provide further evidence of a cat bond market reaching a level of greater equilibrium.

Beyond this, it’s possible market conditions may be very good for any new issuers that can bring a cat bond to market during the summer months, as there may be capital available at some funds and a demand for new paper to invest in.

While issuing US wind is always a challenge during the wind season, ILS fund managers and investors we speak with would all welcome some diversifying risks in cat bond form at this time.

Which all suggests that if this market balance persists, there could be an opportunity for particularly strong execution through the coming weeks.

Find details on every catastrophe bond transaction in the Artemis Deal Directory.