Returns on catastrophe bonds are exceeding those on corporatedebt by the most in nine months as investors facing record-lowyields chase returns detached from economic performance.

The bonds, designed to protect insurers from payouts on naturaldisasters such as hurricanes, have gained 1 percent this month,compared with a loss of 0.9 percent for company debt, according tothe Swiss Re Cat Bond Total Return index and Bank of AmericaMerrill Lynch data. Returns on dollar-denominated cat bonds werehalf those of corporates in 2011 as an earthquake and nuclearaccident in Japan sparked record losses.

Issuance in the $15 billion market for catastrophe bonds isgrowing at the fastest pace in five years as investors seeksecurities that don't depend on payrolls growth in the U.S. or asolution to Europe's sovereign-debt crisis. An average yield ofabout 9 percentage points more than short-term lending ratescompares with 5.89 percentage points on junk bonds in the U.S.

“It's not related to how the U.S. economy is doing, to how theglobal economy is doing, the concerns about growth, currencies ordeficits,” Shiv Kumar, a managing director and head of financialinstitution structured finance at Goldman Sachs Group Inc., said ina telephone interview from New York. “The sector itself has provento be a diversifying, objective, clean play compared with debt andequity markets.”

While insurers are boosting yields on cat bonds by sellingriskier debt as the U.S. hurricane season progresses, chances of amajor storm lasts every year through November, according to theNational Hurricane Center. That means higher coupons and investordemand is accounting for accelerating returns, according to FermatCapital Management LLC's John Seo.

“The proven track record, especially through recent broadermarket volatility, has also helped establish the credibility of catbonds,” Seo, managing principal at the Westport, Connecticut-basedfirm overseeing $3 billion of the debt, said in an e-mail.

Elsewhere in credit markets, the cost of protecting Europeancompany debt from default fell for a second day, reaching thelowest in five months. Banco Santander SA, Spain's biggest bank,and France's Societe Generale SA raised money as issuance inEurope's corporate bond market continued to defy the usual summerslowdown.

Europe Risk

The Markit iTraxx Crossover Index of credit-default swaps tiedto 50 mostly junk-rated European companies fell five basis pointsto 563, the lowest since March 20, according to prices compiled byBloomberg.

In the U.S., the Markit CDX North America Investment Grade Indexdropped 1.2 basis point yesterday to a mid-price of 98.5, thelowest since May 3.

The indexes typically fall as investor confidence improves andrise as it deteriorates. Credit swaps pay the buyer face value if aborrower fails to meet its obligations, less the value of thedefaulted debt. A basis point equals $1,000 annually on a contractprotecting $10 million of debt.

Banco Santander is selling 2 billion euros ($2.5 billion) oftwo-year senior, unsecured bonds in the first public offering froma Spanish bank in more than five months, according to a bankerfamiliar with the matter. Paris-based SocGen, France'ssecond-biggest bank, offered a benchmark-sized note in euros due inFebruary 2018, said another banker, who asked not to be namedbecause he's not authorized to discuss the transaction.

Bonds of Laboratory Corp. of America Holdings were the mostactively traded dollar-denominated corporate securities by dealersyesterday, with 79 trades of $1 million or more, according toTrace, the bond-price reporting system of the Financial IndustryRegulatory Authority. The Burlington, North Carolina-based providerof medical testing services sold $1 billion of debt in its firstoffering in almost two years.

The U.S. two-year interest-rate swap spread, a measure of debtmarket stress, rose 0.25 basis point to 21 basis points. Themeasure narrows when investors favor assets such as corporate bondsand widens when investors seek the perceived safety of governmentsecurities.

The Standard & Poor's/LSTA U.S. Leveraged Loan 100 indexrose for the 11th time in 12 days, increasing 0.02 cent to 94.94cents on the dollar, the highest since June 3, 2011. The measure,which tracks the 100 largest dollar-denominated first-lienleveraged loans, has climbed from 91.8 on June 5, the lowest sinceJan. 6.

Leveraged loans and high-yield, high-risk, or junk, bonds arerated below Baa3 by Moody's Investors Service and lower than BBB-at S&P.

Higher Returns

Cat bonds have returned 5.3 percent since the end of March,following a 0.45 percent gain in the first quarter, according tothe Swiss Re index.

Company debentures from the most creditworthy to the riskiesthave returned 4 percent since March 31, following a 3 percent gainin the first three months of the year, according to the Bank ofAmerica Merrill Lynch U.S. Corporate & High Yield Masterindex.

The outperformance this month is the most since cat bonds lost0.03 percent in November while company debt plummeted 1.94 percent,according to Swiss Re and Bank of America Merrill Lynch indexdata.

While issuers of U.S. corporate bonds are obtaining record-lowborrowing costs, reaching an unprecedented 3.9 percent on Aug. 2,cat bonds are enticing investors with higher yields.

Cat bonds issued in dollars in 2012 paid an average 915 basispoints more than short-term benchmarks, up from 899 basis pointslast year and 881 in 2010, Bloomberg data show. High-yield bonds inthe U.S. pay a spread of 589 basis points, down from an average 607in 2011 and 630 the prior year.

“The yields on cat bonds are actually relatively normal, whichrelative to everything else means attractive,” said JohnBrynjolfsson, chief investment officer at hedge fund Armored WolfLLC, which oversees $735 million and owns cat bonds.

That's helped boost issuance of the debt, which insurers sell toreduce the risk of claims from hurricanes and floods to pandemics,to $3.6 billion through the first six months of the year, the mostsince 2007, according to Swiss Re data. Companies have sold $887billion of dollar debt this year.

“When you're seeing a growing asset class that's still offeringyield, that's what attracts folks,” said Cory Anger, a managingdirector at broker-dealer GC Securities. “When you're looking atthe absolute return you're getting in other asset classes, peopleare concerned about the level of income that they're able togenerate.”

Investor Appeal

Citizens Property Insurance Corp., Florida's state-ownedinsurer, more than tripled its target amount in a debut sale ofobligations designed to protect against losses from hurricanes to$750 million in April, the biggest offering on record of cat bonds.Goldman Sachs managed the sale.

“We absolutely did not know that we would have the opportunityto upsize this thing three times,” Sharon Binnun, chief financialofficer of the state's largest property insurer, said in atelephone interview. “In the interest-rate environment that we'rein now, investors are looking for another vehicle through which topark at least a portion of their investment portfolios.”

The debt, effective for two years, priced to yield 17.75percentage points more than a money-market fund of Treasuries inwhich the proceeds will be stored.

If insurance losses in the 2012 and 2013 hurricane seasons passa threshold, principal will be transferred to Citizens PropertyInsurance and bondholders will lose that portion of their principaland the future interest payments allocated to it, according to anApril 20 document posted on the insurer's website.

Payments linked to natural disasters help insulate the debt fromthe risk that a fragile U.S. economic recovery will hindercompanies' abilities to boost sales or generate the cash requiredto pay off obligations.

Employment increased by 163,000 last month, helped by a pickupat automakers and health-care providers, after a revised 64,000June advance, Labor Department data showed. The median estimate of89 economists surveyed by Bloomberg called for a rise of100,000.

The jobless rate, based on a separate survey of households,climbed to 8.3 percent in July, marking the 42nd straight monthabove 8 percent. Retail sales by auto dealers to department storesrose 0.8 percent more in July, the biggest since February and firstgain in four months, according to Commerce Department figuresreleased on Aug. 14.

Portfolio 'Diversifier'

Cat bonds, which gained 3.3 percent last year even after a 4percent drop in the weeks following Japan's 8.9-magnitude tembloron March 11, have posted positive gains every year since at least2002.

The debt returned 2.3 percent in 2008, when the collapse ofLehman Brothers Holdings Inc. contributed to a 37 percent tumble inthe S&P 500 index of U.S. stocks and an 11 percent loss forcorporate debt.

“It's a diversifier to almost any other asset class out there,”Judy Klugman, a managing director at Swiss Re Capital Markets,which issues and underwrites the securities, said in a telephoneinterview. The bonds “provide real value for issuers and investors,so that can only mean it has real legs for the future.”

Bloomberg News

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