[ Dow Jones Newswires -- December 1, 1997 ]

El Nino Buoys Catastrophe Bonds As Hurricane Season Ends


Dow Jones Newswires NEW YORK --

Bond investors are among the few people to have profited from El Nino this year. Hurricane season ended Monday. For holders of USAA Inc.'s $477 million of catastrophe bonds, that means the worst is over - and they have El Nino to thank. The securities, which are backed by the cash flow from reinsurance premiums, were privately placed in June by Merrill Lynch & Co., Goldman Sachs & Co. and Lehman Brothers. In return for taking on the risk of a hurricane doing more than $1 billion of damage to the East Coast before June 15, 1998, investors were paid super-generous yields. Now hurricane season is over, and, thanks in part to El Nino, the East Coast has not suffered any major destructive storms. Hence, the bonds look like a much safer bet, and their yields relative to Libor have shrunk accordingly. Hurricane season officially lasts from June 1 through Nov. 30 every year, according to the National Weather Service. "There's no question that the probability (of a major hurricane hitting) is nothing like it was at the beginning," said Isaac Efrat, a vice president at Moody's Investors Service who rates catastrophe bond issues. "There's risk, but it's nothing like what it was before. Presumably the market is already pricing that in." "The likelihood of a tropical storm or hurricane in the off-season is near zero but not quite zero," said Jerry Jarrell, acting director of the National Hurricane Center, a unit of the National Weather Service. "There's always that outside chance." Jarrell said that of the 545 hurricanes in the center's database, which goes back to 1886, only seven have occurred during the off-season, and none of those struck the U.S. "As near as I can tell, there has been no damage from an off-season storm in our database," he said. "It's doubtful that a hurricane that could cause that much damage would occur before June 15," said Steven Goldstein, the manager of the Cat Bond Investors fund, a joint venture between PX Re and Phoenix Home Life Mutual Insurance Co. that invests in catastrophe-linked bonds. "I'm not excessively worried," Goldstein said of the USAA bonds. "I don't think there are too many concerns ... It's a good hold." However, the bonds didn't rally Monday, because they had already tightened gradually as hurricane season waned and investors realized that El Nino, the periodic warming of eastern Pacific, had reduced the likelihood that a major storm would hit the East Coast. "There has been spread tightening based on positive experiences for the vast majority of the risk period," said Andy Kaiser, managing director in the insurance products division at Goldman Sachs. In June, the triple-A, "principal-protected" class was priced to yield 276 basis points over one-month Libor, while the dicier, "principal at risk" class was priced to 576 basis points over Libor. By early October, the principal at risk class was trading at around 300 basis points over Libor, by mid-October it had tightened to 230 basis points over the benchmark, and one month ago it was quoted inside of 100 basis points, traders said. By then, the principal-protected securities were trading at around 50 to 65 basis points over Libor. Monday, traders said the principal-protected class would hypothetically trade in the ballpark of 25 basis points over that benchmark, although any further selling is unlikely, because the bonds now look so attractive. "In an ideal world the spreads should be tightening monthly, because the risk is so concentrated in so small a period of time," said Isaac Efrat, who rates catastrophe bonds for Moody's Investors Service. "By mid-September you know half the risk is over. By then you should have seen a significant portion of the risk premium gone."

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