Yesterday QBE Insurance Group (QBE) shocked the share market with a huge profit warning:
QBE Insurance Group foreshadowed a 40%-50% fall in annual profit for calendar 2011 following a late spike in catastrophe claims. QBE said its US$1.28bn profit in 2010 could be chopped in half, partly because the claims bill generated by severe floods in Thailand exceeded its expectations.
There are any number of questions that this will pose but the most significant pertain to QBE’s role in the financial system. Along with Genworth, QBE subsidiary QLMI provides some 80 per cent of Australia’s lenders mortgage insurance. These are the premiums paid by high LVR borrowers to insure the banks against mortgage losses (not the borrower as some commonly believe).
Although the attached release does not mention LMI losses, there is still potential fallout for the subsidiary. QLMI has a credit rating two notches above it’s parent company (currently rated A- by Standard and Poors) but is very thinly capitalized. It is probably the case therefore that its rating relies in some measure upon the assumption that in the event of large mortgage losses, the QBE parent will provide it’s subsidiary with further capital rather than let it become insolvent.
The question is if, as of yesterday’s losses, the QBE parent’s credit quality is diminished, how does that effect QLMI? Will it have to raise more capital to support it’s premiums? Given the dividend is expected to be cut (falling from 66 cents to only 25 cents) it appears the capital preservation is already underway on QBE’s balance sheet. QBE also ominously warned that its other business in fixed interest investments will be hit by “unrealised losses…due to rising credit spreads”.
The timing of this profit downgrade is not good. With unemployment likely to rise into 2012 and housing related losses expected to mount, as well as banks paying huge premiums for offshore funds and APRA busy with stress tests, QBE is in an unenviable position.
Announcement in full:
QBE announcement
QBE is a bottom picking buy down here at $11.
What’s your risk level on the buy? Get out at $10? $9? $8?
What’s your asset allocation on the buy? 1% of portfolio? 5%? 10%?
Do you buy a big bunch now, or average in? Average up or down?
For a bear on housing, have you realised that QBE’s exposure to the LMI market will shrink on any meltdown or large falls?
And that lending is at 30 year lows and decelerating?
Just some thoughts.
id buy them as an investment not a trade and only get out depending on whats happening to the company not the share price. looks like a lot of one offs (CATS)outside the companies control rather than anything structurally wrong with the co. 2011 was a pretty crazy year. as frank said the outlook for 2012 is positive and are getting strong premium rate increases.
if we take these as one offs the earnings bounce back very strongly this year and so does the div (10% yeild for 2012). they are also getting killed investing in low yeild US bonds. if we are looking at a genuine US recovery (i think so) the yeilds will rise later this year or next and they can start earning a better return. not to worried about LMI.
yes im a definate housing bear but dont think you will see a crash with mass defualts and MLI claims. the delfating household debt bubble is highly deflationary so the RBA will cut rates alot more than the 1 or 2 cuts forcast. most people will keep their jobs and pay their mortgage. thge investors that took out 100% loans are the worry but would have had equity in their primary reisdence that they will now likely lose. but still dont see mass defaults here. QBE is a BUY.
I’m having a look right now to invest long term, but there’s plenty to consider. Like who will steer the ship when O’Hallaran retires. Does anyone but him understand the complexities of QBE’s insurance book???
not saying it was a trade.
good analysis, but:
whats your risk management?
whats your asset allocation?
A “BUY” rating is just a word, not an investment decision.
those things will be different for everyone. personally, id back the truck up, put them in the bottom draw and revisit them in 24 months time when i reckon they will be +50% higher than where they are now.
And SUN and IAG
And if they’re not?
What if they’re down 10% in two years time? Or flat? Or the dividend is cut further (high possibility).
What if other opportunities avail in the interim that make higher returns?
Your risk management equals drawers and capital allocation equals trucks?
I’m sure we all have different ways of approaching stock market investing, but this seems……different…..thanks for sharing GB
“Your risk management equals drawers and capital allocation equals trucks?”
yeah, sounds silly but thats pretty much my bottom of the market strategy.
putting it like that has made me laugh though prince! thats very funny.
It seems the Motley Fool agrees with GB’s theory. Buy and hold.
http://www.smh.com.au/business/why-im-buying-qbe-shares-next-week-20120113-1pyi8.html
I might buy a 12 month ATM call position I think.
Prince, Can’t QBE just let QLMI go if the losses become too large rather than taking the whole company down with it. Which would you choose as CEO?
It’s an interesting situation because the banks are assuming they are covered in a worst case housing scenario, however what happens if the LMI providers become insolvent. who wears the losses then?
I would have never been in LMI in the first place.
The cost is always borne by the taxpayer.
So private investors win in any upside. Taxpayers pay for the downside (yet again). What a great world we live in.
You almost HAVE to be invested in the market to hedge against any losses you wear as a taxpayer
+1 exactly
A light bulb moment there, Jason.
+1
So betting on QBE is betting on (at least) four other things: the weather, the US Treasuries market, Australian mortgage defaults and the equities markets in general.
We know the weather is getting worse all the time, driven by climate change; we know the US Treasuries market is locked into ZIRP for many years to come as first the household and then the government sectors gradually de-lever and re-balance; we know defaults in the Australian mortgage market are very low, so, if anything, are a downside risk rather than an upside risk for QBE; and we know that global equities are anyone’s guess.
So betting on QBE is not as simple as buy-and-hold. Insurers trade in risk. That is their business. They are meant to have a good grasp of risk probabilities and their allied costs. If they have been caught by “unforeseen” disaster claims – and their business is knowing how to rank the risks of these things – what hope do common-or-garden punters have of making smart bets about the same risks?
The insurers offer exposure to all kinds of risks, including one that is very difficult to appraise, and for which there is no statistical/actuarial database – and that is the effects of climate change. Consequently, it is not obvious how to price insurers, and even they seem to be acknowledging they do not understand the risks they have been buying.
Looks like a share price discrepancy based on bad news that has been confirmed. Definitely an opportunity IMO – but is not clear cut. I thought that QBE was reasonable price before announcement – yet the announcement didn’t really change a lot did it? We already knew about the catastrophes and low yielding bonds. From here, probability would suggest that the positives outweigh the negatives. Will probably drift around a bit and eventually head back up to $15 once the bad sentiment falls away.
The amount of premiums that QBE takes in has been increasing the last few years, unfortunately for them, their reinsurance costs have gone up much faster, jumping up 40% between 2009 and 2010.
They also have a much healthier balance sheet than the other big insurers (IAG, SUN and AMP), not that that’s saying much, but it means they can bleed longer.
If these have been one off events things could turn around for QBE. That said the dividend would have been my main reason for buying, I’ll probably look at them again later.
MMMM… Glad I sold at $17 p’d off that I didn’t sell at $26…. I recall that after sept 11 2001 they dropped by about 50% on unknowns….. rebounded well and peaked at $26ish …. As I understand it In surance is meant to be a zero sum game…. the money is made on the “pot” by using that to create the income…. well just now those investments are not so good and QLMI is only a potential disaster and this has been built in before this is not new news, all Insurers pass on premium increases to the Consumer, and put funds aside for disasters… this is just part of the big wheel….. I will keep the few I still have left and may look for further buying ops… cutting the Div is sensible recapitalisation!