As the pound goes down, brokers making US dollars are seeing an unexpected benefit in the recession....
As the pound goes down, brokers making US dollars are seeing an unexpected benefit in the recession. Ana Paula Nacif outlines the bright prospects.
Thanks to a favourable dollar-sterling exchange rate, London brokers could reap the benefits of a more profitable balance sheet this year. As a result, with these brokers set to make more money and premium rates finally moving upwards in some insurance lines, overseas buyers are keeping their eyes peeled for increasingly profitable businesses opportunities.
Olly Laughton-Scott, managing partner of Imas Corporate Advisors, told Post in January that US and Indian parties in particular are showing heightened interest in London market brokers due to the depreciated value of sterling (29 January 2009, p4).
And David Ross, chief executive of broker AJ Gallagher, also pointed out that for many brokers and underwriters in Lloyd's, the tumbling price of sterling is benefiting the bottom line. "An account that paid $10m in premium at the beginning of 2008 might now be paying 10% more at renewal, but because of the exchange rate movement it's more like a 35% increase in premium when converted to sterling and the broker is finally able to make some money." (Post, 22 January 2009, p24)
The current situation sits in marked contrast to last year when the weak US dollar and softening rates were putting EC3 brokers under pressure. With a typical London market broker having about 50% of its brokerage income denominated in US dollars - according to David Lang, director in the London and Bermuda markets team at Ernst & Young - these brokers can arguably say they are winners in a credit crisis that has otherwise thrown many worldwide organisations into a heightened state of alert. The same fortunate situation currently applies to those whose income is denominated in euros.
"The dollar-sterling exchange rate has declined by 35% in the period from July 2008 to February 2009," says Mr Lang. "This movement in the exchange rate could lead to a 17.5% increase in the brokerage income of a London market broker - when the US dollars are converted into sterling - and as a result give rise to a significant increase in the turnover and hence profitability of these entities."
So the news could not be better, especially considering most brokers have expenses in sterling that are not adversely impacted by exchange rate movements.
"Many financial results of brokers and other agents for the 2008 financial period have yet to be published but I am aware of some brokers predicting they will report good increases in their profitability," confirms David Coupe, partner in the corporate insurance group at law firm Clyde & Co.
However, before they are able to reap the rewards, some brokers will have to deal with hedging issues. Toby Esser, group chief executive of Cooper Gay, who is expecting to "benefit significantly from the weak pound", explains that although London-based brokers earning in dollars or euros are likely to see their results significantly improved, some will not detect much improvement over the next few months - especially those that have hedged their bets at high rates, perhaps 1.9 or two to the dollar.
He advises brokers to take advantage of the current climate and "hedge forward as long as they can". In any case, he predicts brokers should benefit from exchange rates over the next three to four years.
Mr Laughton-Scott agrees, adding that although some brokers will not see benefits in the short term, due to their hedging strategies, "profits are likely to go up in the long term".
Mr Coupe explains that brokers who have hedged at high rates for long periods forward are now trying to break these hedging arrangements or renegotiate them, "but banks are reluctant to deal even if it threatens other existing banking relationships".
Consequently, some brokers have resorted to buying dollars to reduce their currency exposure. "It seems that everyone in the insurance market was slightly caught out by the speed with which the exchange rate dropped against sterling, including Lloyd's of London," adds Mr Coupe.
The rapidity of change does indeed seem to have surprised the market. "This has happened in the past," says Mr Esser, "but the difference this time around is that we had a bear market for about six years and the dollar turned around in just six months."
With this in mind, experts are finding it difficult to predict how long the bonanza will last, especially considering current market volatility. For example, Mr Laughton-Scott told Post in January that it will likely only be a "relatively small window" when sterling is on the fall (29 January 2009, p4) but some experts remain optimistic about the future.
"You can't know whether the situation will stay the same," says Mr Esser. "In fact, FX traders have different ideas; some believe the sterling weakness is likely to continue while others say it will get back up soon."
Lloyds TSB Corporate Markets is betting on the good trend for brokers to last at least until the end of the year. "We are predicting the dollar will end 2009 at 1.37," says Seb Kafetz, the firm's relationship manager. "If that were to be the case," he continues, "it will bode well for Lloyd's brokers who will continue to benefit from the exchange rate, depending on their hedging arrangements."
So with market conditions shining the spotlight on London brokerages, overseas buyers are eyeing them as attractive opportunities. Mr Lang explains that because equity markets have seen significant reductions from July 2008 to February 2009, London market brokers may also have seen a 30% reduction in their market capitalisation over the same period. "Given this position, the scenario is one where the market capitalisation of the broker is at a low point at a time when the underlying profitability of the broker is moving to a higher level," he explains.
So a market where brokers are more profitable, rates are hardening and the sterling is cheap signals a good combination for potential buyers - especially those in the US, who can access a more affordable business with a prospect of higher returns.
But overseas buyers are not only after the acquisition of a profitable asset. According to Peter Allen, partner in transactions and restructuring of Grant Thornton's financial services group, the main driver for the market is a favourable business synergy.
"There has been interest from overseas intermediaries, especially those looking to place business in London," he explains. "They want to improve their access to London, which is even more important when the market is hardening - something we have seen especially in the property and casualty arena."
Having said that, Mr Allen points out that non-UK brokers are rarely successful at directing all their business through the London entity they acquire. "Nonetheless, they will get the benefit of owning the business through which they put other business transactions."
Despite volatile market conditions, it seems some brokers can look forward with a certain degree of optimism. As Mr Coupe points out: "The economic downturn could provide a silver lining for insurance brokers and agents."
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