QBE’s poor timing

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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.

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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

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