After 300 years, Lloyd’s of London has issued its first bond to improve its capitalisation and its ratings – underlining the venerable market’s modernisation. Edward Russell-Walling reports.
History seemed to be catching up with itself when one of the world’s oldest markets knocked at the door of one of its youngest in search of capital. Yet Lloyd’s of London is such a unique credit, with such a stormy recent past, that corporate bond investors needed some convincing. It has taken Lloyd’s a little over three centuries to issue its first – and highly successful – bond, raising the equivalent of £500m in lower Tier 2 capital.
Founded in a London coffee shop in 1688, Lloyd’s developed into a one-of-a-kind specialist insurance market, where underwriting capacity was provided by individual ‘names’, who accepted unlimited liability.
This model came under severe strain in the early 1990s as asbestos and pollution risks turned sour, and many ‘names’ were unable to meet their obligations. As part of a wholesale reorganisation, corporate capital was admitted to the market in 1994, and today makes up more than 80% of the market’s £15bn capacity.
Lloyd’s is not a company but a corporation, a society incorporated by its own Act of Parliament. As such, it has no capital or retained earnings of its own. Its members are grouped in syndicates run by managing agents, and write business – brought to them by Lloyd’s brokers – for their own account.
Change in attitude
“For years, the corporation did little more than turn the lights on and off,” says one market insider. “Today it takes rather more interest in its members’ business.” It has had little alternative. Apart from the need to restore the market’s reputation, Lloyd’s has also ceded its prime original function – that of regulator – to the Financial Services Authority.
After more sizeable losses following 9/11, the corporation reinvented itself as guardian of the Lloyd’s ‘franchise’, with the managing agents as franchisees. The aim was to create a “disciplined marketplace”, principally by monitoring and improving underwriting and risk management standards. Each year, managing agents must now submit their syndicates’ business plans for the corporation’s approval.
Calculating capital
Members’ capital is now calculated according to a risk-based model and the society’s own safety net is being strengthened. In the normal course of events, claims have been paid out of the syndicates’ Premium Trust Funds (PTFs). If those become exhausted, claimants can call on members’ risk-based capital. Next, there is the personal declared wealth of the remaining unlimited liability names. Behind all that stands the Lloyd’s Central Fund, worth nearly £800m and funded by a levy on members. The fund has the right to call down more money from PTFs, up to 3% of the market’s capacity.
A post-9/11 decision was taken to make the central fund more robust. “One reason was to put upwards pressure on our ratings,” says Luke Savage, a former CFO of Deutsche Bank’s equities business and now Lloyd’s director, finance and risk management. He points out that the corporation’s insurer financial strength rating of A from Standard & Poor’s has been stable since January 2002, despite many downgrades in the wider insurance market.
“Another reason was to strengthen our regulatory capital position,” Mr Savage says. In the wake of 9/11, there are also competitive advantages in being seen to be well-capitalised.
Two new funding mechanisms have been introduced. The first involves loans from PTFs. To qualify as upper tier 2 capital, the loans are perpetual, although in practice they will be made each year for three years, being repaid in the fourth. These should bring in £300m in fresh capital.
The second was the subordinated bond issue, rated BBB+. This was split into a £300m 21-year non-call 11 tranche, priced at 207 basis points (bp) over gilts, and E300m 20-year non-call 10, priced at 172bp over mid-swaps. The bookrunners were Citigroup and Royal Bank of Scotland.
“Issuing in two currencies helped to drive the pricing, by addressing a wider investor base,” Mr Savage says. “As an opportunity to get out there and explain who we are, it raised our profile in the European investor market as well.”
Stunning response
Lloyd’s is quite unlike any other credit that analysts have ever seen, however, and initial investor response was guarded, to say the least. Some who chose not to participate remain dubious about the transparency of the risks assumed by syndicates. Nonetheless, an intense schedule of roadshows – for nearly 100 potential investors – produced a stunning response. The issue was five times oversubscribed.
“The idea of Lloyd’s asking the market for half a billion pounds and being offered £2.5bn is a testament to the changes that have taken place here in the last three years,” says Mr Savage.
