Mexico has brought its fourth catastrophe bond to the market in a deal that saw the International Bank for Reconstruction and Development (IBRD) tap its capital-at-risk programme for just the third time since its creation in 2014 – and only weeks after a ground-breaking pandemic bond transaction.
The World Bank created the IBRD’s capital-at-risk programme as a way for it to shift developing market natural disaster risks to the capital markets. Its first transaction, in 2014, was a $30 million bond linked to earthquake and storm risk in the Caribbean. The recent pandemic bond was the second capital-at-risk notes deal.
Now the Bank has added to its tally of insurance-linked issuance by wrapping up in early August a $360 million catastrophe bond designed to provide emergency help in the event of natural disasters in Mexico. The deal brings the total raised in catastrophe risk trades by the Bank – either as arranger or through an intermediation role through bonds or swaps – to $2.5 billion, with about $1 billion of that coming in just the last two months.
Mexico is well known to cat bond investors. It was the first sovereign to tap that market, back in 2006, through a $160 million earthquake deal from Cat-Mex, an SPV, with payments to Swiss Re. It returned in 2009 and rolled that issuance again in 2012, with both deals using the World Bank’s MultiCat programme, an off-the-shelf scheme that helps countries tap the markets.
But the creation of the capital-at-risk programme from the IBRD, part of the World Bank group, means that the IBRD can now issue cat bonds directly on behalf of other entities.
|Preparing for the worst|
|Catastrophe risk transactions, World Bank involvement, ordered by date of first trade|
|Beneficiary||Type||World Bank role||Total to date ($m)||Date|
|Caribbean Catastrophic Risk Insurance Facility (CCRIF)||Earthquake, hurricane||Intermediation (bond/swap)||203.5||Annual, 2007-2014|
|Malawi||Drought||Intermediation (swap)||19||Annual, 2008-2011|
|Mexico||Earthquake, hurricane||Arranger||605||2009, 2012|
|Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI)||Earthquake, hurricane, tsunami||Intermediation (swap)||232.5||Annual, 2012-2016|
|Uruguay||Drought, oil price||Intermediation (swap)||450||2013|
|Philippines||Earthquake, hurricane||Intermediation (swap)||206||2017|
|Mexico||Earthquake, hurricane||Intermediation (bond)||360||2017|
|Source: World Bank|
Investors lose principal if a deal’s parametric triggers are activated as a result of a disaster, with proceeds passed to the Mexican Fund for Natural Disasters (Fonden). That's happened before: the Pacific storm tranche of Mexico’s 2012 MultiCat deal was triggered, leading to investors losing half their principal.
That 2012 deal had stepped payouts at 50% or 100% of principal. The new deal has more: four steps for the earthquake risk and three for the storm risk. The transfer of funds in the event of an eligible event is managed by insurance firms Munich Re and Agroasemex. Munich Re was joint structuring agent for the bond issue alongside GC Securities, while GC Securities was sole bookrunner. Both firms work regularly with the World Bank and were on the recent pandemic deal.
About one third of Mexico’s population is exposed to natural disasters ranging from storms, floods, earthquakes and volcanic eruptions, according to the World Bank, with 71% of its GDP at risk from two or more natural hazards.
Unlike the recent pandemic bond deal – which was unusual in being designed to pay out while a disaster was continuing, with the hope of containing it and mitigating its final impact – the Mexico transaction is intended to pay out after events that are by their nature sudden and fast. Deals like these are also not intended to cover the insured losses of a disaster. They are more about emergency relief. After all, if there were a huge earthquake in Mexico City, $150 million would not go very far in terms of the total losses. But it would be a very important contribution to the basic emergency relief work of rebuilding roads, constructing tent cities and the like.
“We are leveraging Mexico’s leadership in developing risk insurance mechanisms against natural disasters, and the World Bank’s innovative use of private sector instruments to transfer risk to the capital markets,” said Arunma Oteh, the World Bank’s vice president and treasurer.
Another potential deal is in the offing. The Pacific Alliance – a trade bloc that groups Mexico, Chile, Peru and Colombia – is considering a joint cat bond issue in conjunction with the World Bank. It might emerge before the end of the year, says one official familiar with the plans.
The new deal’s structure is similar to the sovereign’s previous visits to the market: three classes, each referencing different risk. The Class A covers earthquake risk, the Class B covers hurricanes approaching from the Atlantic, while the Class C covers storms from the Pacific. A Pacific tranche is handy for investors looking for diversification. Atlantic storm risk for Mexico is fairly closely correlated with Florida risk, and tranches referencing it tend to see higher pricing and lower demand.
Pricing across all tranches tightened about 50bp-60bp from guidance, according to Michael Bennett, head of derivatives and structured finance in the treasury department of the World Bank. The $150 million Class A earthquake tranche priced at 6-month Libor plus 412bp, the $100 million Class B Atlantic hurricane risk at plus 892bp and the $110 million Pacific tranche at plus 552bp.
The deal was oversubscribed, with almost 40 investors coming into the book. For Bennett, that result illustrated the buyside’s resilience in the face of the 50% loss on the previous trade’s Pacific storm class. It was also a decent result considering the timing of the trade, which came very close to the start of the hurricane season, at a time when investors might already be full up on their exposure to the sector.
Indeed, the first storm of Mexico’s 2017 season came about a week after the latest trade settled. Tropical storm Franklin was upgraded to a Category 1 hurricane and hit the country’s Atlantic coastline on August 10. It quickly weakened after making landfall, however.
Dedicated insurance-linked investors took most of the latest deal, with 78% of the Class As, 69% of the Bs and 60% of the Cs. Asset managers took between a fifth and a quarter of each tranche. Individual non-specialist investors typically allocate very small holdings to the ILS class, looking for a small diversification play that is largely uncorrelated with their mainstream investments.
They can often be some of the largest global investment firms, however, meaning that the asset manager buyer base is now a meaningful support for ILS transactions. On the IBRD’s pandemic bonds, for example, asset managers bought 20% of one tranche and 42% of the other.
Mexico’s latest deal is treated as a three-year maturity, in spite of the fact that while the earthquake tranche matures in August 2020, the hurricane risk classes mature in December 2019. What matters to investors is the number of hurricane seasons covered, and the early maturity still covers three of those.
Data sources matter to investors when it comes to evaluating parametric triggers, say those working in the ILS arena. The IBRD’s pandemic bond trigger documentation referenced data from the World Health Organization, which tracks cases of disease and numbers of fatalities constantly throughout a disaster.
Notably, given that it is effectively a sovereign transaction, Mexico’s latest deal is using non-Mexican data sources – the likes of the US Geological Survey and the National Hurricane Center. Its parametric triggers relate to measurements such as earthquake depth and shaking severity, or millibars of air pressure for storms.