Despite a restrictive economy, five companies within the Lloyd’s market raised capital in the first quarter of 2009. Seb Kafetz considers the reasons why, and what to expect next
The first quarter of 2009 saw over £620m of new equity raised by five companies operating in the Lloyd’s market. The money was raised despite the near closure of the credit markets and against a backdrop of plunging global share prices.
The factors that enabled these companies to successfully raise new equity include:
i) the need and desire to raise new equity;
ii) the features of the share issues; and
iii) the ability for the market to continue to raise equity and/or alternative capital sources.
Last year was one of the most costly on record, with over $50bn of claims. Coupled with the dramatic fall in the value of equities and alternative securities, it is estimated that between $100bn to $150bn of capital exited the reinsurance industry in 2008.
Recent history has shown that capital flows quickly return to the industry following periods of large losses. This is amply demonstrated by the two waves of private equity backed start-ups in 2001 and 2005, and the equity “reloads” from institutional markets.
As we moved into 2009, however, the industry was unsure of its ability to raise new money. The institutional markets appeared to be closed, and hedge funds and private equity investments were curtailed due to the demand for redemptions and the lack of ability to leverage up investments. Nevertheless, in the first three months of the year, Omega, Chaucer, Catlin, Beazley and Hardy all managed to raise money from their shareholders.
While a consistent backdrop to the equity raises was a desire for more capital to take advantage of perceived rate increases for organic growth, this accounted for only approximately half of the total money raised. Other factors included:
a) the need for many of the firms to put in approximately 20% more capital into their business to take into account the substantial change in the sterling/dollar exchange rate;
b) capital for acquisitions (for example, Beazley’s purchase of the US MGA First State); and
c) capital to fill a hole left by investment losses.
Rights issue or share placing?
Whilst the capital raises appear to have many common features, a closer look will highlight numerous differences in both the form and some of the financial metrics behind the transactions. Catlin and Beazley chose to undertake rights issues, whilst Omega, Hardy and Chaucer undertook share placings. The key differentials are that a rights issue generally allows an unlimited amount of new share capital to be issued (subject to shareholder approval) and provides flexibility on the discount offered to entice subscription (although in theory should be valued neutral), whilst a placing and open offer is likely to be limited in size to circa 30%-40% of shareholders capital.
A rights issue is also fully underwritten by a broker or existing shareholders in advance, whilst a placing is pre-marketed with investors before launch, which in turn makes it simpler for new shareholders to subscribe to rather than a rights issue (subject to existing shareholders ability to “claw back” shares pro rata). Generally, a placing can be completed in a shorter timetable than a rights issue.
The above factors had some bearing on the type of issue launched by each insurer. For example, Chaucer had a greater desire to complete the raising in a short timeframe. It needed to raise a specific amount of money and potentially attract new investors, so a placing was more appropriate.
Catlin, on the other hand, had more time and flexibility, as the proceeds of the issue were intended to be employed for future opportunities, and so they went down the route of a rights issue.
In addition to the above structures, a further feature of the capital raises that was considered by a number of companies was the willingness of hedge funds and private equity to participate in equity issues by taking minority stakes (less common in the UK market but known as “pipes” in the US).
The next wave
The five issues mentioned above all took place in the first three months of 2009. Since then, there has been little issuance of note in the sector, despite a continuing hardening of the market. Explanations for this include potential investor fatigue due to the oversupply of stock in the sector, loosening credit markets (as an alternative), as well as a lack of suitable issuers (both size and need).
Looking back on previous hardening markets, the debt and equity markets have both been utilised to increase capital. Now there are signs that the debt markets are starting to reopen. Participation in the various government schemes has helped to free up capital, which will allow banks to increase their lending.
The bond markets are also starting to show activity in the financial institution space, albeit to date dominated by guaranteed bank issues. Some of the other forms of sub-debt common in the market, such as finance provided through pooled collateralised debt obligations, remain firmly closed.
Looking forward, one can likely expect continued use of the bank debt markets and opportunistic use of sub-debt to allow companies to gear up for organic growth, with any future equity issuance in the sector being more targeted to support strategic activity.
We think that the equity markets remain open for Lloyd’s insurers, but post the recent wave of issuance, we expect the bulk of future equity raising to accompany strategic as opposed to opportunistic moves. IT