IB Talk

Paul Lucas  09:45:26 

Welcome to IB talk, the leading podcast for the insurance industry across the UK and Ireland brought to you by Insurance Business. 

Narrator  09:45:35 

This episode is presented in partnership with Travelers. In the latest episode of IB talk, two industry experts from Travelers Europe join us to address many of the current challenges underwriters in the financial industry are facing and what they need to consider as the market evolves. 

Mia Wallace  09:45:52 

Hello, and welcome to the latest edition of IB talk the insurance industry podcast brought to you by Insurance Business. My name is Mia Wallace, senior editor of insurance at insurance business. And today we'll be discussing underwriting considerations for financial institutions, underwriters in the current economic environment, and who better to get to grips of this topic than not one but two financial institutions insurance stewards. So I'm delighted to be joined here today by Chris Unwin, director at Travelers Europe and Sam Meehan, development underwriter at Travelers Europe. Thanks to you both for joining me here today. 

Chris Unwin  09:46:38 

Thanks, Mia. It's great to speak to you today. So I'm Chris Unwin, director in the financial institutions team at Travelers Europe. So I joined travelers in lockdown at the start of 2021. And I'm based in the Manchester office. And I'm focused on underwriting in our core space of asset managers, banks and insurance companies.  

Mia Wallace  09:46:56 

Fantastic and yourself, Sam? 

Sam Meehan  09:46:58 

Thanks, Mia. I'm delighted to be here. So I'm a development underwriter within the UK and Irish team. I'm based in Dublin. So I work across both the Irish and London markets. And that's across all sectors within the financial institution space. 

Mia Wallace  09:47:12 

It's brilliant to welcome you both here today and to get to grips with one of the really big questions on the minds of financial institutions, brokers everywhere, about what are some of the core issues currently facing the banking industry? And, Chris, from your perspective, what are some of the issues currently facing the banking industry in the US? 

Chris Unwin  09:47:30 

I think one of the really interesting things about working in the FI market is that there's always different economic challenges to consider. And that's especially true in the banking sector at the moment. So in the space of a few days, at the start of March, we saw Silicon Valley Bank collapse after a run on the bank, we saw regulators step in to close Signature Bank and to protect deposit holders. We also saw silvergate, capital announced that it was winding down operations and entering into liquidation. I think, for me, one of the most high profile, it seemed to be Silicon Valley Bank, which was also operating in the UK. This was a bank that was heavily focused on the needs of startups and the tech industry. An analyst had been concerned that the bank was heavily concentrated in the tech sector. So it's particularly vulnerable to shocks from that sector. As we saw in the news recently, it collapsed eventually as a result of a run on the bank. And that triggered some shock waves in the banking world that we haven't really seen since 2008. Now, I think it's hard to point to a single reason for its failure. But one factor was definitely the management. There's a lot of criticism that was made over the management of the firm. So red flags had been raised as early as 2019 by the regulators, and that expressed concern that it didn't hold enough cash to meet deposit requests. There are also concerns over modeling that the bank was using to assess impacts of interest rate rises. Now the bank had benefited from a decade of near zero interest rate and huge deposit inflows from the tech sector. So that invested heavily in long dated fixed rate government bonds. And as interest rates sharply rose, the value of those bonds fell, which weakened the balance sheet and impacted profitability. At the same time, funding for startups was reducing, so clients started to withdraw deposits. Now, SVP wasn't looking to sell those bonds at a loss, but was forced to when deposit requests start to build, and they built up really quickly. So there's $42 billion in requests on the Eighth of March, and over $100 billion of withdrawals expected the next day. And that led to a vicious cycle of deposit requests and bond sell offs, forcing the regulator's to step in and close the bank. Now as an underwriter, we need to consider the impact that rapid change of interest rates would have on the business model of our insurance. So do they hold assets on the balance sheet that sensitive to swinging interest rates? And have they hedged any of that exposure? And what impact would arise and interest rates have on their customer base? So in theory, higher rates attract savers, but on the flip side, that puts a strain on borrowers with increased provision for non performing loans. But overall, it should have a positive impact on bank profitability. I think we also need to look carefully at any criticism from analysts and regulators and assess their responses to them. I also think we should say that the regulatory environment also contributes to the failure of SVB. So previous US administration rolled back some of the regulatory burden. So previously, banks With more than 50 billion in assets were subjected to more strenuous capital and liquidity requirements, more onerous stress testing, and the need to hold plans for a living well if they failed, so that 50 billion threshold for increased scrutiny was raised to $250 billion. And that resulted in SVB, having lower supervisory requirements, and lower capital and liquidity requirements. Now, this coincided with a period of rapid growth for the bank. And they went from around $70 billion in assets in 2019, to over 200 billion in 2021. And deposits grew by 220%, compared to an average of 26%, across all US banks. So it's difficult to say whether the increased regulation would have prevented the failure of SVB. But it's fair to say that warning signs would have been raised earlier, and the bank would have been more resilient as a result. And when you look at comments from the regulators around other US bank failures recently, very similar themes emerge. So one of the main comments you see is poor risk management, banks have pursued rapid growth without developing and maintaining an adequate risk framework. Another observation they make is an over reliance on uninsured deposits. So for example, 89% of SVB deposits were uninsured, that's less stable deposit base, which is more likely to be withdrawn. If banking confidence is shaken. It's also interesting to note that the full amount of customer deposits, not just the 250k was protected. And that might set a precedent for how to deal with bank failures in the future. 

Mia Wallace  09:51:45 

Fantastic. And thank you for that overview of what's happening in the US. But I wonder what are the issues facing European banks? 

Chris Unwin  09:51:53 

So much of the focus recently has been on the US market. We've seen difficulties in Europe too, with the rescue of Credit Suisse, which was purchased by its rival UBS recently. Now, the bank had been under significant strain for some time, and regulators had been very vocal in recent years, over serious failings in controls, and reporting deficiencies. So when the news broke in the US surrounding their bank troubles that prompted a huge sell off in banking stocks, and Credit Suisse shares at an all time low. There were further negative headlines, so delays in reporting financials and significant customer outflows. And the biggest shareholder refused to provide further funding. Now, the Swiss National Bank tried to shore up markets with a liquidity package. But ultimately, it didn't work. And a deal was announced that UBS would buy credit Swiss. Now, I think, a few points I'd raised in respect to this. So as an underwriter, we need to be conscious of the size and complexity of banks, we need to pay careful attention to conduct so fines and penalties give you an idea of the nature of their operations. And we also need to be conscious of contagion. So events in one jurisdiction impacts other markets in ways we might not have expected. I'd also note that scale doesn't automatically mean stability, and rapid growth needs to be balanced with robust strengthening of risk management procedures. I think another interesting point to come from the events was the treatment of AC one bondholders. So Credit Suisse had around $17 billion of 81 bonds in issuance. Now, usually, bank holders would rank higher shareholders and shareholders are expected to take the losses first. In the structuring of this transaction, the bond values were wiped out, whilst equity holders received around $3 billion in UBS shares. Now that doesn't seem to follow the usual conventions. And following this legal challenges have been launched by bondholders who lost out that's forced European and UK regulators to distance themselves from this decision. And they've said that they will continue to rank bondholders above shareholders, that has implications for the investment management industry. So investment funds that hold 81 bonds within the portfolio may suffer unexpected writedowns particularly on Swiss investments. And that could lead to claims from investors if they suffered material losses from holding at one bonds. And there could be implications on debt pricing, particularly on the 81 bonds in the future. 

Mia Wallace  09:54:08 

And Sam from your perspective, how to the US and European banking environments actually compare? 

Sam Meehan  09:54:14 

The main difference here is the size and scale of each. The US has over 4100 banking entities where the UK has around 350 and our depth 350. Only about 150 of those have their head office and their main focus in the UK. So just off that the US regulator has over 25 times event entities to oversee now both do have structures in place to stimulate growth of smaller banks. This is an attempt strengthened increase the amount of what each would respectfully label mid tier banks. Each jurisdiction has streamlined, albeit different regulatory approaches around oversight and capital requirements, size and scale need to be considered here. But the UK has that in place with banks with assets under 20 billion. Well, as Chris highlighted earlier, the US has that in place of banks with assets about 250 billion US dollars, government deposit guarantees in the UK that's 85,000 versus 250,000. Now following recent events, as discussed earlier, there has been plenty of discussion around the benefit of raising or even removing both of these guarantees the political motivations of each current government respectively. Yeah, I think fair to say in different places, the US has gone from a Trump administration with an aggressive approach to the regulatory framework to the current Biden administration who attempted to cut back some of these changes. While the UK are in a post Brexit state, where the government tends to prove the value of leaving the regulatory environment of the EU, this was recently demonstrated by the recommendations to loosen the cap requirements for life in general insurers. And it's fair to say that banking was on the radar for similar changes. However, due to the current state of affairs, I'd say any plans of that will certainly be put on hold. A pleasing similarity between the UK and US, certainly in recent times, is that both regulators have shown that they can respond quickly to distress the fair. Locally, the fast tracked approval for HSBC is purchased on SPV. And in the States, the First Republic bailout by JPMorgan, which is already America's largest bank, and under normal circumstances sale would not have been approved as it would exceed the regulator's threshold of no bank holding more than 10% of US total deposits. 

Mia Wallace  09:56:18 

Thank you, Sam. And you and Chris are both touched on several of the key issues affecting the banking industry. But I question what impacts inflation and rising interest rates are having on other financial institutions, such as asset managers and insurance companies? 

Sam Meehan  09:56:33 

Yes, Sure. Thanks, Mia. First touch on insurance companies a couple of key points, their investment performance. Now factoring in specific investment approaches, it's a fair presumption to make the high interest rates should lead to a better return on investment, and the negative here being claims inflation or client expenses. Now, this will impact all lines of insurance some more quickly and easy identify than others. property claims as an example, have almost immediately been materially impacted. In the UK, we experienced an unprecedented increase in construction materials inflation, which peaked at 26% in June last year. Now long tail lines might not move as quickly as this but certainly things like solicitors fees, impact and defense costs and settlements will impact clients inflation. Now, asset managers inflation and interest rate increases are going to have a materially impact on every strategy that review and write. And this will be compounded issue when leverage has been adopted. But I'll just touch on a few that we do commonly deal with. Now private equity. In terms of volume, we haven't seen the level of activity of last year, which was at record highs. The first quarter of this year saw the value of m&a deals dropped by 45% when compared to year on year at 2023. It already started slow but the banking crisis did compound this of the key risks that I'm seeing with respect to existence sales, I have noticed an increase in trade buyers as opposed to financial buyers. This may be due to increased interest rates amongst other macro issues. And at a portfolio company level the knock on of these issues because also lead to an increase in insolvencies, which is of concern, credit funds with respect to new transactions similar to the impact on banks higher returns with potentially higher defaults. Alternatively, there may be funds dominated by all transactions at low interest rates that now face underperformance issues. This could lead to an increase redemptions and issues from that. And real estate funds been another obvious strategy affected. We're always conscious of LTV ratios and refinancing run rate in these that's now materially heightened. 

Mia Wallace  09:58:39 

Thanks for that Sam. And Chris., considering the current FY market conditions, what are some of the key underwriting considerations that needs to be taken into account at this time. 

Chris Unwin  09:58:49 

So I think we need to recognize the really challenging economic conditions at the moment. So we're still feeling the effects of a global pandemic, which puts a huge strain on public finances have caused a restriction in labor supply. So we had the great resignation, where many people left the workforce or retired early. And there are record numbers of long term sick in the UK as the continued escalation of the war in Ukraine, which has had an effect on supply of raw materials and energy, and a significant strain on consumer finances. So in April, CPI was at 8.7%. But food inflation was around 20%. And that's put a significant squeeze on living standards, with wages struggling to keep up with inflation. So the ONS estimates that half of adults are buying less food in their weekly shop, and one in three is cutting back on non essential journeys. And the FCA estimates that three quarters of a million households are at risk of mortgage default. So in that context, consumer confidence is likely to be low deposits are likely to be unstable, credit quality is likely to deteriorate, and there's a risk of an increase in non performing loans. I think we need to look carefully at how banks are treating their customers so many are facing financial difficulties. So how do they treat their customers who are struggling to keep up with loans and mortgage repayments? I also think we need to be conscious of the speed at which events can develop. So SVB was the first major digital run on the bank. Regulators cited social media as a contributing factor and new spreads really quickly. So for example, over $140 billion in deposit requests were received over two days at SVP, which is unsustainable. deposits can be moved really quickly, so you can do it from your phone anywhere in the world without needing to carry around the block for a cashier. I also think we need to be conscious of the speed and pace of regulatory action. So regulators took swift and decisive action to banks, the size of UBS and Credit Suisse were merged in a small space of time, mergers are difficult to complete successfully. There's significant challenges for a bank to overcome. Now think underwriters need to keep abreast of regulatory changes and assess the impact these will have on a financial institution. We need to assess the board and governance framework to ensure the caliber and experience of the management is sufficient to navigate the changing regulatory environment. And we also need to note that multi jurisdictional banks increase the complexity of regulatory oversight. And there's increased scrutiny of management actions which can lead to investigations into actions of directors. And I think for us, it's important to meet clients face to face and get a sense of the culture of the firm, and where our firm is productive. That gives us more comfort that they can navigate the complex regulatory framework. I'd also note that certainly in the UK, there's been efforts to increase competition in the banking space. But there may be additional challenges for smaller banking institutions. So we may see a flight to quality, with customers moving their business to larger and more resilient institutions. 

Mia Wallace  10:01:32 

Fantastic and from the insights you've both offered, so you can see it this is a really tumultuous time for the markets. So how has Travelers Europe placed itself in a position of strength to help support brokers and clients maybe starting to view that Sam? 

Sam Meehan  10:01:47 

Thanks Mia. One of the main reasons I enjoy working here is that we have a complementary skill set within the team as a result of a mix of backgrounds and experience. Chris here being one with over 10 years experience within the FYI market. We have a banking backgrounds, illegal and cleans backgrounds. And myself and wallet who's managing director of FYI, travelers have extensive broking backgrounds. So I believe that from our clients perspective, they do have access to a wide range of expertise within our team. As I mentioned earlier, I'm based in Dublin, Chris here is in Manchester, we have another team member based in Glasgow. So outside of our London presence we do truly have a regional representation with within the UK and Ireland. 

Chris Unwin  10:02:27 

I'd say we'd take time to review each risk on its individual merits, we can provide bespoke coverage based on client requirements. And when things do go wrong, we've got an expert in house claims team with legal backgrounds to help our clients through the process of making a claim. And I think the final point that I would make is our financial strength. Travelers was founded in 1864 and has a long history behind it. We pride ourselves on resilience and a solid financial base. Despite the significant disruption in the financial markets, our investment portfolio, capital position and liquidity remain very strong. 

Mia Wallace  10:02:57 

Thanks Chris and for brokers looking to find out more what's the best way to get in touch? 

Sam Meehan  10:03:03 

Yep, deliver a contact sheet just on the link below here. All of us are approachable and all of us are open to business. 

Mia Wallace  10:03:10 

Fantastic to hear. And thank you so much, Chris and Sam for such a cogent analysis of what's happening in the FI insurance space during such tumultuous period. It has been very appreciated. Thanks very much. 

Sam Meehan  10:03:23 

Thank you very much. 

Mia Wallace  10:03:24 

And thanks also to everybody for tuning in. And I look forward to welcome you next time here on IB talk. 

Narrator  10:03:31 

Thank you for listening to this episode of IB talk. For more from the team at Travelers visit them at travelers.co.uk. Thank you for listening to IB talk. For the latest episodes, be sure to follow us on all major listening channels.