Private Market Resists Weather Bonds

Market observers had their interest piqued earlier this month when a pair of domestic energy giants sent out books on the first-ever privately issued weather bonds.

Such securities are similar to catastrophe bonds in principle, with the event risk of hurricanes and earthquakes being replaced by the more gradual risk of long-term temperature variations. As Donald Thorpe, assistant vice president at Duff & Phelps Credit Rating Co., added, "The weather bond holders are more likely to have some loss but are far less likely to lose all of their money than if they had invested in CAT bonds."

The new launches, from Koch Industries Inc. and Enron Corp., were considered by some to signal the groundbreaking of a new conduit for ban asset class thus far confined to the public trading floor of the Chicago Mercantile Exchange. "These companies are trying to set a benchmark, to set standards, to take a leadership role," said one analyst.

In spite of such optimism, though, the standard practice of responding tentatively to boat-rockers has seemed to prevail. Following Koch's initial issue of $200 million worth of high-yield senior notes via agent Goldman, Sachs & Co., a lack of investor demand forced the company to downsize the deal's total price tag to $50 million. When the deal closed two weeks ago, the transaction's $25 million first event tranche was rated single-B-minus by Duff & Phelps and carried a coupon of 15.7%, while its $25 million second event risk tranche was rated double-B by Standard & Poor's and yielded 8.7%.

"As far as pricing, we certainly weren't nearly as successful as we wanted to be," acknowledged Jeff Porter, co-head of Koch's weather derivatives group. "Some investors said that the deal was a bit too complex. Maybe we'd have fewer [weather] stations next time and make some of the contracts a little more standard."

Although the Koch deal certainly fell short of expectations, at least Porter can be content in the knowledge that his securities found buyside homes. Such a "success" is in direct contrast to the Enron offering, which remains in marketing limbo without any apparent signs of life. That deal, which is being underwritten by Merrill Lynch, was reportedly sent out as an $105 million offer at around the same time as the Koch securities.

One third-party source who attended a seminar on both deals at the recent Weather Risk Management Association conference in Lake Buena Vista, Fla., characterized the Enron bonds as similar to the Koch notes in general structure, but that the former were significantly simpler than the latter. Although he expressed surprise when he heard of Enron's relative failure, he did note that Koch provided a better analysis of the market risks via a presentation by Risk Management Solutions. RMS President Hemant Shah confirmed that while both issuers had hired his organization, it had only been contracted to do road show work on behalf of Koch.

An Enron spokeswoman refused to comment on any aspect of its beleaguered weather bonds.

Despite their frosty reception, it is fairly certain that weather bonds will continue to show up in private investor logs. For example, one sellside source has confirmed that Koch was expecting to finish up an identical securitization to its most recent deal sometime last week.

However, speculation that private weather bond volume will gradually rise may be a bit premature. "Market expansion is probable, although not yet imminent," said Shaw. "The short-term opportunity is really with the energy and utility industry because an originator has to get acquainted with actual loss outcomes based on heating degree days and cooling degree days, and that's a process of discovery that the utility industry has already gone through."

Based in Wichita, Kan., Koch is a private U.S. company with extensive holdings in petroleum, agriculture and chemicals. It has reportedly generated about $35 billion in sales in 1998. Houston-based Enron is the top buyer and seller of natural gas in the U.S. It is publicly traded on the NYSE under the ticker symbol ENE. It reported 1998 sales of over $31 billion.