QBE Bond Risk Surges as U.S. Expansion Sours: Australia Credit Risk

By Narayanan Somasundaram | December 13, 2013

Bond risk on QBE Insurance Group Ltd. halved in the first 11 months of the year before surging this month as the company said it would lose money.

Credit-default swaps on QBE have climbed 41 basis points since Nov. 30 to 180 basis points yesterday, the biggest rise after Qantas Airways Ltd. The advance in the insurer’s bond risk is undoing the sharpest improvement this year among 25 names in the Markit iTraxx Australia index. Its spread over the benchmark widened to the most since March this week.

Standard & Poor’s yesterday lowered its outlook on QBE to negative, after Fitch Ratings and Moody’s Investors Service downgraded the insurer’s issuer rating this week following forecasts for a $250-million loss in 2013 due to write downs at its North American operations. A further deterioration in the U.S. business and profit warning may spur a revision, S&P said.

“The question everyone had following Moody’s and Fitch’s downgrades was whether S&P will follow,” said Anthony Ip, Sydney-based strategist at Deutsche Bank AG. “While S&P has changed its outlook, it isn’t as bad as a full downgrade. The spreads are unlikely to widen as sharply as they have over the last few days.”

S&P expressed concern about the outlook for QBE’s North American operations and said it may consider lowering the insurer’s grade from A-.

S&P Concerns
“A downgrade by no more than one notch would be considered should there be further deterioration in group operating performance, such as material reserve strengthening and/or write-downs over the next one-to-two years,” S&P credit analyst Mark Legge said in a statement yesterday.

The issuer credit ratings relate to debt issued by QBE and changes will not have a “material impact” on the business, the insurer’s Chief Executive Officer John Neal said in a statement today. “We will be working to return the negative outlooks to stable with improved performance and continued reduction in our debt-to-equity ratio,” he said.

QBE’s shares have lost 32 percent since they resumed trading Dec. 9 after a trading halt ahead of the financial update. The fall wiped out the 42 percent gain for the year and turned QBE the worst performing of three Australian insurers after earlier leading.

The insurer’s predicted loss compares with a mean estimate of $1.07 billion in profit for the year from 11 analysts surveyed by Bloomberg. It recorded a profit of $761 million in the previous 12-month period.

QBE has missed analysts average profit estimates for the past five years and has repeatedly downgraded the following year’s guidance, JPMorgan Chase & Co. said in a Dec. 10 report. Its insurance margin is expected to drop to 6 percent this year from 25.6 percent in 2007, company filings show. It has forecast a 10 percent insurance margin in 2014.

U.S. Woes

“While the company is undertaking initiatives to improve profitability, we think it will still take 12-18 months before the benefits of these initiatives begin to flow through,” JPMorgan Chase analysts led by Sydney-based Siddharth Parameswaran wrote. Risks, though reducing, haven’t fully passed, they said.

Among the insurer’s North American operations, QBE bought Balboa Insurance from Bank of America Corp. in 2011 to provide coverage for homes with distressed borrowers and crop insurer NAU Country Insurance Co. in 2010. While Balboa has been pressured by investigations into whether insurers overcharged, QBE expects more claims this year from falling corn prices.

Debt Gearing
QBE’s gearing, a measure of financial leverage, will rise to 44 percent by the end of the year, exceeding its stated target of 30 percent to 40 percent, UBS AG said Dec. 9.

Capital levels were above the regulatory benchmark, QBE said, revealing plans to raise $500 million in subordinated convertible notes to redeem $250 million of similar notes and repay senior debt maturing in March 2014. The firm has the equivalent of $4.5 billion in debt outstanding, data compiled by Bloomberg show.

Moody’s downgraded QBE’s issuer rating to Baa2 from Baa1 Dec. 10 citing weakened profitability, internal capital generation and debt service coverage measures. Fitch lowered its issuer default rating to A- on Dec. 11 and the outlook to negative.

“It is difficult to rule out the risk of further issues in the U.S.,” said Toby Langley, a Sydney-based analyst at Nomura Holdings Inc. “I’d expect a more radical course of action to be taken if this kind of problem was to resurface again. It could potentially result in a reassessment of the group’s structure, such as a sale of assets or break up and retreat into the Australian market.”

IJ Ed. note: A.M. Best has also downgraded QBE’s issuer credit ratings (ICR) and has affirmed the financial strength ratings; the outlook on both ratings is, however, negative.

–Editor: Candice Zachariahs

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