Hurricane Lidia rapid intensification could drive Fonden cat bond price pressure

Hurricane Lidia rapidly intensified on-approach to Mexico’s Pacific coast late yesterday, with the storm’s sustained wind speeds doubling and its central pressure dropping rapidly as it neared landfall, which could serve to drive some price pressure, or uncertainty at least, to the Class D notes of the Mexican governments IBRD / FONDEN 2020 catastrophe bond today.

We reported on hurricane Lidia’s approach to Mexico yesterday, as we understood that rapid intensification was a possibility and some catastrophe bond fund managers and investors were keeping an eye on the storm.

When we first published that article, Lidia’s winds were at 100 mph and central pressure was estimated at 971 mb, so at the time the risk to the Class D notes of the FONDEN catastrophe bond, which are exposed to Pacific hurricanes impacting Mexico, was deemed still low.

But, fast-forward a matter of hours and hurricane Lidia became a Category 4 storm, with 140 mph winds and a central pressure that fell to an estimated 942 mb at landfall, which has changed the picture somewhat and could serve to drive some price pressure to the exposed Class D cat bond notes in the secondary market.

To recap, the Mexican governments World Bank facilitated $485 million IBRD / FONDEN 2020 catastrophe bond provides it with disaster insurance protection against both earthquakes and hurricanes, all on a parametric trigger basis, with a $125 million Class D tranche of notes that provide parametric insurance protection against Pacific hurricane events.

The parametric trigger for the cat bond’s Pacific hurricane coverage is based on landfall location and minimum central pressure of any storm that approaches the Mexican coast and in order for the Class D Fonden 2020 cat bond notes to face any loss of principal, the minimum central pressure of hurricane Lidia would need to fall to 935 mb or below.

The cat bond has been designed to respond to the most severe of hurricanes, with three tiers of payout possible, starting at a 25% payout of the Class D tranche for a storm with a central pressure at or below the 935 mb threshold.

Hurricane Lidia saw its wind speeds double and central pressure drop by 43 mb in just a twenty-four hour period and this rapid intensification brought the minimum central pressure, as estimated in the NHC’s update at landfall, to 942 mb, so just 7 mb above the figure required for the Class D cat bond notes to be triggered and a 25% payout of the $125 million tranche to come due.

It’s important to note that the minimum central pressure reported by the NHC of 942 mb is still estimated, it is not a recorded figure.

The FONDEN catastrophe bonds, of which there have been a number over the years, all use what is known as the “best track” data from the NHC, which is a post-event report that can sometimes be published weeks, or even more than a month after a storm makes landfall.

Within that report, the NHC (which is the named storm reporting agency for the FONDEN cat bond trigger) will extrapolate the minimum central pressure along the track of hurricane Lidia and also revisit the data, performing a post-event analysis of its estimates, using any additional inputs that are available to it.

Which means there is some uncertainty over the final central pressure figure, at the time the storm was within the parametric trigger zone for the cat bond, that will be released in the NOAA best track data and report.

Amplifying this uncertainty could be the contributions of hurricane storm chasers, as there were a number on the ground in the landfall region for hurricane Idalia yesterday.

Included among the storm chasers that were in Mexico for hurricane Lidia’s landfall, were Josh Morgerman, who the catastrophe bond community will be familiar with after his on the ground pressure recording for hurricane Patricia in 2016 was thought to have contributed data towards determining the size of the loss cat bond investors faced with the MultiCat 2012-1 Class C cat bond notes.

That time, the NHC referenced pressure recordings made by storm chasers within its final tropical cyclone report on the storm, with this data potentially helping it in extrapolating the pressure along the best track data that was reported.

At this stage there aren’t any reports from storm chasers that might have recorded the central pressure of hurricane Lidia, but they are sure to come in time.

All of which could amplify a level of uncertainty over this storm, as hurricane Lidia’s central pressure was reported to have been 942 mb at 3.30pm MDT yesterday, at which time the NHC said “Some additional strengthening is possible before Lidia makes landfall this evening.”

Lidia made landfall at around 6pm MDT, with the reported central pressure the same at 942 mb, but it is possible that the pressure declined on approach towards land, at which stage the storm will have made its passage into the parametric box for the FONDEN 2020 Class D cat bond note trigger.

As a result, there could be some heightened uncertainty surrounding the pricing of these cat bond notes, for a time at least, while the market makes a determination as to whether it’s possible this tranche of notes will need to be considered at-risk until the finalised NHC report is released.

You can read all about the $485 million IBRD / FONDEN 2020 catastrophe bond and every other cat bond transaction in the Artemis Deal Directory.