NHC hurricane Otis report suggests Fonden Class D cat bond loss will be ~50%

The U.S. National Hurricane Center (NHC) has delivered its final tropical cyclone report for 2023’s hurricane Otis, putting the minimum central pressure of the storm at 922mb and 929mb at landfall on the Mexican coast, which we’re told still suggests the $125 million IBRD / FONDEN 2020 Class D tranche of catastrophe bond notes face around a 50% loss.

Recall that, hurricane Otis made landfall in the Acapulco area of Mexico’s Pacific coast as a Category 5 storm last October and based on the reported pressure from the NHC at the time, it appeared hurricane Otis would trigger the $125 million Pacific hurricane Class D tranche of the Mexican government’s IBRD / FONDEN 2020 catastrophe bond.

As a result, investors have been anticipating a loss of principal to the notes.

Investment manager Plenum Investments said at the time it believed there was a “high probability” that holders of the notes faced a 50% loss of notional, which would equate to a $62.5 million loss for the cat bond market.

Specialist insurance and reinsurance-linked investment manager Twelve Capital highlighted that there would be some uncertainty with respect to the final central pressure figure for hurricane Otis, but still believed at the time that it was probable the Mexican government’s exposed catastrophe bond tranche would face a 50% loss of principal.

With this catastrophe bond, after the storm has hit the final data used to work out whether a triggering event has occurred comes from the NHC’s final tropical cyclone report for a hurricane.

That report for hurricane Otis has now been delivered and it estimates that the minimum central pressure of the storm fell to 922mb after its rapid intensification and deepening.

But, at landfall, the minimum central pressure is estimated to have been 929mb, according to the final report.

Now, it’s important to understand how the trigger structure works with the World Bank facilitated Fonden catastrophe bond.

The parametric trigger for the cat bond’s Pacific hurricane coverage under the $125 million Class D notes is based on landfall location and minimum central pressure of any storm that approaches the Mexican coast.

For the notes to face any loss of principal at all, the minimum central pressure of hurricane Otis would need to be 935 mb or below, at the time it crossed into the parametric trigger zone.

The parametric trigger for this World Bank Fonden cat bond is made up of a line drawn along the Mexico coast and it is the minimum central pressure a hurricane has, as well as where its centre breaches that line, that defines the payout amount, which can be 25%, 50% or 100% of the principal outstanding, or an amount calculated on a linear basis between those payout steps.

Sources have told us today that early analysis suggests that the central pressure of hurricane Otis, when extrapolated along its path, looks like it broke through the parametric trigger’s line at around the 924mb mark.

It’s important to note that the parametric trigger line is offshore, hence the pressure needs to be extrapolated out along the path of hurricane Otis and derived at the point the storm crossed that, for the final figure that determines the quantum of the loss can be finalised.