Has QBE been forced to raise around $2 billion of extra capital by the key insurance regulator, the Australian Prudential Regulation Authority?
An announcement from the insurer yesterday with its 2014 interim profit report raises that question – especially when there was no explanation in a webcast from management about why a series of moves to boost its capital base and improve its quality were being made now, and not earlier.
The moves by the company include raising new capital ($810 million in a share placement and an issue to retail shareholders), partially floating its lenders mortgage insurance business, and selling assets and businesses in Australia, the US central and Eastern Europe, as well as dropping the discount on the shareholder dividend reinvestment program. These suggest the company has made a major change in approach to risk.
All up the company will raise more than $2 billion, with a big swag of that to be used to repay existing debt. But $1.5 billion will remain in the company to strengthen the balance sheet.
At the same time QBE management says the company will chase more riskier assets for its portfolio of up to 15% by the end of next year from around 5% at the moment. It will look at buying emerging markets debt, equities and high yield bonds (junk bonds), all with the aim of boosting returns from its investment portfolio.
The company’s chief financial officer Pat Regan told the webcast that a move to lift the prescribed capital ratio (which is set by APRA) will need around $US1.5 billion in extra capital.
CEO John Neal hinted at that when he told a webcast that the moves would improve the company’s position both with regulators and rating agencies around the world. He said we will "significantly and comprehensively improve capital metrics".
Given that APRA’s new insurance capital rules were mentioned in the statement, as was the company’s self-explained need to have enough capital to withstand downturns, which is always another area of interest for regulators, there’s a feeling from the QBE report that the company has been told to raise more higher quality capital.
QBE 1Y – QBE has a shocker, wants more capital
On top of that were the comments about how the group would benefit from converting "intangible capital" such as goodwill (which is worthless in a downturn) into ‘tangible capital" such as equity.
Goodwill is the difference between the price paid for the assets in an acquisition, and their actual book value. It is essentially accounting blue sky invented to handle premiums paid by acquiring companies.
In economic downturns (such as the GFC) or when companies encounter problems (such as QBE has been having now for the past five years with weakening earnings), goodwill isn’t worth the value in the company’s accounts.
Goodwill in the balance sheets of financial institutions make regulators exceedingly worried. QBE had intangible assets of $US4.525 billion on its balance sheet at June 30 (up from $US4.480 billion a year earlier).
This year’s figure was just under 10% of total assets of $48.9 billion. If it has no value in a downturn, then the impact on QBE’s solvency could be dramatic.
"When executed, these initiatives deliver significant additional cash and capital resources that will substantially improve the Group’s financial flexibility and ability to better withstand a reasonable range of downside scenarios," the company said. This includes de-gearing the company and its balance sheet, as the statement explained.
"Debt to equity is expected to fall materially from its current level of 38.4% to comfortably within the Group’s revised target debt to equity range of 25%-35%.
"The initiatives are likely to have an even more meaningful impact on both debt to tangible equity and tangible premium solvency as a result of the conversion of intangibles into tangible capital.
"Similarly, the initiatives will have a meaningful impact on the Group’s APRA PCA multiple which is expected to increase from its current level of 1.56x to comfortably within the Group’s significantly more demanding revised benchmark PCA multiple range of 1.7x-1.9x," directors said.
The webcast was told the increase in this Prescribed Capital Amount will rise to around 1.78 by the end of 2015 with the extra $US1.5 billion in new capital raised from the partial float of QBE LMI, the sale of the company’s agency businesses in the US and Australia and the net impact of the various capital raisings announced yesterday and another planned for later in the year.
Those comments leave us with the very strong suggestion that APRA thought QBE was capital light, especially after the last two profit downgrades in December 2013 and in June and has pressured the board and management to repair the insurer’s capital base and quality – especially by cutting the level of intangible assets on the balance sheet.
There were no questions on the timing of the moves at the webcast yesterday, or questions about any role by APRA.
The company said it will partially float its Australian mortgage lenders insurance business – QBE LMI – (following the partial float of bigger rival, Genworth Australia earlier in the year) and sell off its US agency business.
This business is capital intensive, and QBE said yesterday it had to take on extra reinsurance because of the company’s "capital intensity". it now wants third party shareholders to share in that need in a separate vehicle. But QBE says it will hold a majority stake in the listed company.
The QBE LMI partial float will happen in 2015, the company said yesterday.
It will also finalise the sale of its central and eastern European operations and will raise around $A810 million through a share purchase plan and institutional placement. That placement has seen the company’s shares suspended until start of business today .
On top of that the company will raise a further $US700 million in new Tier 2 capital, and repay $US400 million of senior debt that doesn’t meet ratings agency metrics.
The statement on the capital raising moves was issued with the expected sharp slide in profit for the six months to June.
That profit drop was announced late last month. QBE made a net profit of $US392 million ($A424 million) for the six months to June 30, down 18% from $US477 million for the same period last year.
That was due largely to the need to rebuild capital and reserves in its obscure workers compensation business in Argentina.
QBE is paying an interim dividend of 15 cents a share, down from 20 cents paid a year ago for the first half of the 2013 year.
QBE shares have dropped 37% in the past 12 months to hit $10.71 on Monday, compared with the 9.2% gain for the ASX 200 index.
The shares were suspended from trading yesterday to allow the institutional capital placement to take place.
QBE Results Video
