Thursday, 22 November 2012

A Change of Strategy for Aviva?

The announcement of the appointment of Mark Wilson, the former CEO of the largest Insurance company (excluding China) in Asia, AIA, as CEO of Aviva from January 1st 2013 has been greeted positively by the industry. Mark Wilson, born in New Zealand, has spent most his career in South-East Asia both with AIA and AXA.

John McFarlane, the former CEO of ANZ Bank, will resume his role as Non-Executive Chairman. McFarlane spent most of his career with ANZ Bank and Standard Chartered Bank. At ANZ he set a strategy for the Melbourne-based bank of expanding into South-East Asia and it is today the Australian bank with the largest footprint in Asia. Standard Chartered whilst Head Officed in London has Asia as its biggest market.

Back in November 2010 Andrew Moss, the CEO of Aviva at that time, announced that Aviva was withdrawing from Asia to focus on the mature Western European markets (see http://www.itsafinancialworld.net/2010/11/aviva-to-exit-asia.html ), a move that was seen at the time very much as swimming against the tide as the likes of HSBC and Prudential were rapidly expanding there.

One has only to look at the difference in growth between the Prudential (once the target of a hostile takeover by Aviva, which the then Prudential CEO Mark Woods rapidly rejected) and the Aviva to see who had the better strategy.

The new CEO will inherit a clear strategy that John McFarlane in his time as Executive Chairman has laid out that is focused on the exiting of 16 non-performing business segments, including their US business. With challenges in their Spanish, French and Italian businesses and the increasing demand for capital from new regulation such as Solvency II, in the short term there is little opportunity for Aviva to reverse the exit and rapidly expand in Asia. There is an inherent danger that Aviva could end up following the restructuring, including the inevitable significant write down on exiting or disposing of their US business, becoming effectively a UK only insurance business at a time when the UK insurance sector is looking increasingly unattractive given the impact of RDR (the Retail Distribution Review legislation) and the slow growth in the economy.

However it is highly unlikely that an executive of Mark Wilson's calibre would have taken the role at Aviva to run a UK only business. With Wilson's track record of transforming AIA and the combined Asian experience that the Chairman and the Chief Executive have there is little doubt that they will both be looking East for the future growth of Aviva.

Tuesday, 13 November 2012

For Sale: 316 bank branches must go by end of 2013



In June 2010 it was announced that Santander was to buy the branches. Having made the offer, £1.65bn, and completed the local searches (regulatory approval)  when the surveyor's reports came back Santander decided that the RBSG technology estate was in too bad a state (or at least that's the reason they gave) and rather than negotiating a large discount walked away from the deal.

This leaves RBSG in an awkward position. They have just over twelve months to sell or float the branches. Hardly the strongest negotiation position for a seller to be in.

What will any potential buyer get? 1.8m customers, £21.7bn of deposits and 316  branches (2 of the original 318 mysteriously seem to have disappeared - possibly they were in Brigadoon), 240,000 small business accounts and 1,200 corporate banking relationships. This is the equivalent of 5% of the business banking market.

Why would anyone want to buy this business?

SME account customers on average have higher levels of deposits, have higher levels of personal account activity and are more profitable than other customers. They are also more inclined to use branches and want face-to-face contact. Traditionallly this has been a hard sector for new entrants as the Big Four (Barclays , Lloyds Banking Group, RBS/Natwest and HSBC) have dominated the sector and persuading customers to switch (because they have complex relations with their bank) has been difficult. Building an SME banking business from the ground up by encouraging customers to switch from their existing bank is a long slow process as Santander is finding. Therefore for an organisation wishing to enter the market or an existing player wishing to significantly expand their market share this should be highly attractive.

With bank valuations at very low levels, the example of what Cooperative finally got Lloyds Banking Group to settle for and the fixed timescales by which RBSG must agree a deal, this should be a buyer's market and the ability to get the branches for a snip is there. Whilst in 2010 Santander agreed to pay £1.65bn the expectations are that now this deal will be made at around £650m.

Who are the potential buyers?

None of the remaining three of the Big Five banks, Lloyds Banking Group, HSBC or Barclays, even if they wanted to, will be allowed to bid for the business on the grounds of their current market share.

Whilst Virgin Money was in the original competition for the branches, having subsequently bought the 'good bank' elements of Northern Rock, and having expressed initial renewed interest when Santander walked away from the deal, Virgin have effectively rules themselves out. Sir Richard Branson has said that organic growth makes more sense for Virgin Money at this time. Having had to raise large amounts of capital to fund the Northern Rock acuisition it would be very difficult for Virgin to return to the markets and raise even more capital to acquire the RBSG assets. Given the complexity of the integration project for Northern Rock underway it is not all surprising that Virgin has politely withdrawn from the sales process.

Next most often mentioned is Nationwide Building Society. With a track record of growing by the successful acquisition and integration of building societies (Anglian, Portman, Chesire, Derbyshire, Dunfermline to name a few) and positioning itself as different from the banks - more customer friendly and not tarred with all the scandals associated with the Big Five, Nationwide would be welcomed by many as a challenger in the SME banking market. As a mutual going to the markets to raise the large amount of capital could be a significant challenge, but The Cooperative was able to overcome this to acquire the Verde branches from Lloyds Banking Group, not least of all by getting the price significantly reduced.  A factor that may put Nationwide off the deal is the 1,200 corporate banking relationships. This is not a sector that Nationwide currently plays in. Whereas SME banking is often linked quite closely to retail banking and can share a common banking platform, corporate banking is quite different not only in the technology but also in the skills required from the staff.

Nationwide does have the advantage over other potential purchasers that it has spent the last few years investing heavily in a modern core banking system (SAP) which should make migration of the acquisition onto the new platform easier than for Santander. However the new platform isn't finished or fully proven yet, so there would have to be a quite lengthy period where Nationwide would be dependent upon RBS's platform.

JC Flowers, the private equity firm, is also seen as a contender. Having created its One Savings Bank vehicle from the acquisition of Kent Reliance Building Society and having put aside a £1.5bn treasure chest to acquire mortgage books, this money could be re-directed towards the RBSG branches. However the One Savings Bank vehicle is a very small operation and would need to be reversed into the far larger RBSG assets. Neither One Savings Bank or RBSG have modern IT platforms to run the business on so there would need to be a significant investment to make the business a real contender. Going for the SME banking business as the first serious entry into the UK banking market would also raise the risk for JC Flowers. What could be interesting to see is whether JC Flowers could negotiate for a different mix of the branches and customers more towards personal customers and mortgages to make it more attractive to them.

AnaCap Financial Partners LLP, a private-equity backer of Aldermore Bank Plc is also rumoured to be interested. AnaCap has partnered with Blackstone, the world's largest Private Equity firm, to buy banking and insurance assets. Aldermore Bank does not have any branches but still has assets of around £2bn. AnaCap and Blackstone having access to the capital to make this deal happen, however the shape of the deal would potentially be to back an MBO or floatation and to acquire the RBS IT platforms to run it. The question would have to be, given the IT problems that RBSG has had recently, what level of further investment in IT would need to be made to create a true challenger in the SME  and corporate banking markets?

Another private equity firm that could be interested is Corsair Capital where Lord Davies, the former CEO of Standard Chartered, is a partner and vice-chairman. There is no doubt that his experience would bring credibility to a bid, just as Gary Hoffman's presence lent credibility to the NBNK bid for the Lloyds Banking Group Verde branches. This would be very important as getting Bank of England approval for  the executive team of whoever acquires the business is going to be absolutely critical to the success of any bid.

On paper these assets could be attractive to National Australia who with their Clydesdale and Yorkshire Banks do have a significant focus on the SME sector and where there could be synergies. However the UK is not strategic for NAB and there is significant pressure on Cameron Clyne, the CEO of NAB, to dispose of his UK assets even at the cost of a significant writedown. If he were allowed to or wanted to take a longer term view then acquiring the RBSG assets and combining them with Clydesdale and Yorkshire Banks with a view to then selling them could be a way of getting a better return.

Handelsbanken has been making very success in roads into the UK SME banking market with over 150 branches and both high profitability and customer satisfaction. Whilst the addition of  316 branches would significantly increase their scale their preferred approach is grow organically so it is highly unlikely that they will enter the sales process.

Looking at other foreign players who might want to enter the UK banking market the European banks have their hands full in their domestic markets and closing their operations in the troubled European economies such as Italy, Spain, Portugal and Greece, so it is highly unlikely that one of them will enter the fray.

A long shot could be one of the Russian banks such as B&N Bank, Sberbank or VTB. They have the capital and the interest in expanding beyond Russia, but this would have to be a long shot.

Looking at the timescales, the integration challenges and the potential buyers the most likely outcome is a flotation or a management buyout of some form. RBSG needs to go through this process whether it is the final outcome or not as it is important for any potential buyer to believe that there is a competitive bidding process in order to protect the price that RBSG and ultimately the UK tax payer gets for these assets. Whilst Stephen Hester,  the Chief Executive of RBSG, sees the disposal of these branches as a 'distraction' and representing only 2% of RBSG it should be an interesting twelve months.

Update February 3rd 2013: According to Britain's Sunday Telegraph an IPO is now increasingly likely as no one has made a serious offer for the branches. Potential bidders have no been helped by a significant rise in the value of banks in the last few weeks. Whilst it is now most likely that a float will be the outcome, don't assume that this is not an elaborate ploy to force the hand of a potential bidder.

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Friday, 9 November 2012

Are the regulators being realistic about Retail Banking?

Andy Haldane, the Executive Director for Financial Stability told a UK Parliamentary Commission on Banking that the UK banks should create a common technology platform for Retail Banking that would act as a public utility and spur further competition in the sector. This he said would make it easier for customers to swap banks and make it easier for both new banks and existing ones that are currently held back by "antiquated" technology.

The theory would be that all the customer bank accounts along with their numbers could be on a common system so that when a customer wanted to change their bank they wouldn't have to change their bank account number all they would need to do is have that account number point to a different bank. Instant switching with no hassle, no direct debits going missing, no standing orders not paid, no missing salary payments - what more could customers want?

The underlying premise behind Mr Haldane's proposal is that retail banking is an undifferentiated commodity  service and that therefore having an industry common platform makes sense since the only basis of competition is price. Whilst it could be argued that retail payments processing is an undifferentiated service e.g. the transmission of payments using the Faster Payments scheme is standard for all the banks, is that really true for all aspects of retail banking? Certainly Svenska Handelsbanken could successfully argue that the customer centric, branch-based banking service that they operate is very different from the Big 5 banks and is reflected in their success in winning customers from the other banks. The ability of their branch managers to make lending decisions without referral to head office is clearly a differentiator. Equally First Direct customers would argue that the service that they receive from their bank is quite different to that from other banks.

To counter this it could be argued that competing banks could still differentiate their service by overlaying a different customer experience over the top of a common utility platform which would hold all the customer accounts. However the fundamental question is how practical would it be to build a common utility platform?

As Mr Haldane argues the incumbant banks have 'antiquated' systems. This has been very publicly seen by the recent problems that RBS has had. It has also been stated as the reason that Santander walked away from the acquisition of the 316 branches that RBS is compelled to sell.  For a long time it has been obvious that the banks need to replace their core systems in order to keep up with the demands of customers for real time, mobile, digitally enabled experiences. Despite this none of the UK banks has embarked on a wholesale change of their core banking systems. Why? Because replacing the core banking systems is like a full heart, lungs and liver transplant where every vein and artery has to be individually unpicked.

Lloyds Banking Group spent just under £4bn to migrate HBOS onto the Lloyds TSB platform. This was the cost of bringing two banks together onto one of those 'antiquated' systems that Mr Haldane referred to. It has now spent a further £660m on simplifying the systems with more to come.

Commonwealth Bank of Australia has to date spent Au$4bn (£2.6bn) on replacing its core banking platform. That was one bank that is smaller and less complex than any of the UK Big 5.

Even if it was feasible to get the Big 5 banks to agree the specification for a common retail banking platform the cost including migration would be measured in tens of billions of pounds and would take a minimum of 5 years to implement.

The parallels with the NHS IT project where all the NHS records were to be on one system which could be instantly accessible whichever hospital or doctor wherever in the country a patient is are uncanny. The NHS IT programme cost over £6bn. Effectively nothing has been implemented and the programme is seen as an abject failure.

The British Bankers' Association (BBA) responded to Mr Haldane's suggestion by pointing out that the banks have committed up to £850m to produce a system that will make switching bank accounts far easier. This has been underway for some time. This will operate more like a mail redirection service. Clearly this is a far lower cost and far more practical approach than Mr Haldane's proposal.

What is concerning is that such impractical recommendations are coming from such a senior executive with the responsibility for ensuring financial stability. It raises the fundamental question of whether the regulator has taken sufficient time to understand the reality of the current state of retail banking.  This is particularly concerning since this is not a one off. The Bank of England governor-designate, Mark Carney, has, according to the FT,  said of Mr Haldane's views on simpler regulation as 'not supported by a proper understanding of the facts', this doesn't bode well for Mr Haldane's future at the Bank.

Monday, 5 November 2012

Why Sandy could be good for the Insurance industry


There is no doubt that Superstorm Sandy has wreaked damage across both the Caribbean and the east coast of the United States of America. To the layman claims of $15-20bn sounds like a financial disaster for the Insurance industry. However the financial consequences of Sandy may be positive for the London Market and the Commercial Insurance sector in the long term.
It's a financial world (iafw)  talked to Christopher Ling (CL), Commercial Insurance expert and Head of Insurance for BearingPoint in the UK to understand more about why Sandy could have long term benefits for the industry as well as the short term causes. We started by asking him about the size of the loss.
CL: In terms of financial loss this is a medium severity Catastrophe Loss. This makes it large enough for the market to think about buying more reinsurances in the near future without the reinsurers being impacted by a major loss. Rates and hence margins will rise. Sandy should act as a stimulus in encouraging US primary property insurers (more attractive than US liability business) to go out an place orders for more reinsurance business in the London Market. This will lead to an influx of  new risk capital and players creating demand for consultancy services, with the consequential increase in fee income.
People will always need Insurance and losses like this, as sad and as dreadful as they are, serve to remind clients and customers of this.
iafw: So who pays for Sandy and how much?
CL: Catastrophe Modelling Agencies have been busy. Economic total loss estimates have been put at  $30bn-$55bn with some $15bn-$20bn needed to fund estimated insurable indemnity losses.
The consensus is primary US general insurers are likely to bear the brunt of the thousands of small to medium flood, wet damage, denial of access and loss of profits claims. The net written premium of Lloyds of London is currently some £24.8bn ($40.0bn). Whereas economic total loss estimates have been put at  $30bn-$55bn with some $15bn-$20bn needed to fund estimated insurable indemnity losses. US Insurable Cat loss estimates tend to exclude claims under the National Flood Insurance Program as well as the significant parts of the Infrastructure and municipal clear-up costs that are likely  arise. The Queens’ fires could hit Cat treaties, but the biggest unknown is the extent of the Loss of Profits indemnity, which is being driven by clear-up resources and prolonged power outages. It will probably be a couple of months before a level of confidence in the final estimate emerges.
The New York Metro could possibly be led by a major underwriter and reinsured around the market. The Power Plants written on Specialty Risks Energy policies, and there will be some Catastrophe Claims – but generally it is likely that many Reinsurers will have been lucky.
iafw: Whilst there wasn't snow in Manhattan a lot of snow fell elsewhere on the eastern seaboard, Why is it important when the snow melts?
CL: The combination of the two air masses led to intense snowfalls in the Eastern USA. As it is still October, it is likely that as well as disruption, the snow will melt rapidly in the next few days. Depending when it melts will impact the future loss severity. If it melts in 2 weeks’ time,  the tides will be on  Springs again, then it is likely that narrower reaches in urban areas will experience significant localised flooding, which will also impact  lower lying areas of New York.    If it melts in 1 or 3  weeks’ time on  Neaps tides that are not so high, then flooding will be markedly less.
iafw: We've seen a lot of natural disasters over the last few years, how have the  Reinsurance Catastrophe Market been?
CL: The Windstorm Catastrophe Reinsurance market losses in recent years have been benign. The market has broadly been profitable since 2005 (Hurricane Katrina and total Catastrophe Losses estimated at US Insurable losses tend to exclude claims under the National Flood Insurance Program as well as the significant parts of the Infrastructure and municipal clear-up costs that are likely  arise. $118bn).  Even through the Japanese Tsunami, Thai floods and New Zealand earthquakes, the market by and large  managed to fund losses out of cashflow rather than its capital base. The 2011 underwriting year was in fact the second largest Catastrophe loss year on record (to 2005) but the strength of the market and its modelling capabilities has resulted in depressed margins rather than recapitalisation calls.
After the losses of 9/11 (2001), which were comparable in real terms to Hurricane Andrew (1992) a whole new set of investors entered the reinsurance and specialty market as rates rose by 30%  over the subsequent 2 years. This was  the “Class of 2002” – several  major Lloyds capital vehicles created to fund and underwrite Catastrophe and Specialty loss business at these increased rates without the baggage and funding commitments of previous Lloyds involvements and losses.
Since 2002, these capital vehicles have generally made very good returns against their A or A+ paper and the reinsurance market has tended to remain profitable, whilst the primary general insurance market is just coming out of the bottom of a prolonged market cycle dip. However, as with the rest of the economy, there has been nothing to stimulate extra demand for insurance – until 4 days ago.
iafw: This was the first time that we have seen Manhattan hit by such bad weather. Why did this particular storm have such a big effect? 
CL: It must be appreciated that losses of this type are dreadful to the average man in the street or to businesses and some deaths have occurred. However, although winds only gusted at 70-90mph, New York was devastated by a much higher tidal “Storm Surge” of 13’11”  (as opposed to the originally anticipated 11”) caused by wind and negative barometric inversion. The offshore islands acted as limited breakwaters and devastation is likely to be higher here.  Importantly, direct wind-damage losses were not as significant as originally envisaged.
This surge led to severe flooding in Lower Manhattan (much of which is below High Water Springs sea-level) and significant flooding on the Lower East-side from Brooklyn to Queens. Over 375,000 people were evacuated and 650,000 households in the NY  were left without power, including all properties below 42nd Street. Furthermore, a power plant exploded in Queens and there was a major fire burning over a 100 properties. Luckily the New Jersey side of New York harbour has managed to escape the brunt of the flooding due to not being in the path of the travelling flood waters.
Outside of New York,  Atlantic City, Ocean City and parts of Baltimore, Maryland etc. were also  severely hit by flooding and Storm Surges. It should be noted that Levee and flood defence building in the US has not taken priority for many years.
iafw: We've heard a lot about 'Storm Surges' and 'Negative Barometric Inversion' during the coverage of this story as being the loss causes - What are they?  
CL: Sea water piled up into Eastern Seaboard  Estuaries leading to flooding caused by a number of combining  factors;-
·         An intense and highly unstable, humid, anti-clockwise rotating, air-mass; colliding with a cold stable clockwise rotating northerly air mass; led  to extremely rapid condensation (torrential rain),  and the air mass being accelerated in a North Westerly direction to at speeds of 23-28mph (and hence waves) straight up the Eastern Seaboard rivers.
·         Extreme low pressure – sub 940Mb literally “sucked” water-levels up, which were already at a peak due to equinoctial  Spring tides. The average global barometric pressure is 1013.2 Mb. A reduction of 1 Mb results in an INCREASE of just under 1cm in sea-level.
The” bath-tub effect” of water surging  up the Eastern Seaboard  Estuaries caused levels to rise even further when reaching geographic constrictions, such as the Long Island Sound, leading to even higher water levels

iafw: Sandy is undoubtedly a human tragedy which will continue to have a devestating impact on people, particularly as the weather gets colder. As was seen after Katrina, it sometimes takes a disaster of this scale to get the investment in infrastructure that could have prevented the worst effects of the storm to be made. For many years it has been obvious that Manhattan was vulnerable to water levels rising and that the equivalent of the Thames Barrier was needed to prevent this. Irrespective of which candidate is elected as President hopefully the lessons will be learnt from Sandy and the necessary investments in infrastructure on the eastern seaboard will be made which will be good for the economy, good for the residents and will be good for the commercial insurance industry.