Key points
1. QBE announced its half year results to 30 June, 2014 last week with a headline net profit after tax of $392m, down 18% from 1H13.
2. While the results were disappointing for equity holders...again, debt investors received a significant boost with the news that QBE has undertaken a capital plan to strengthen regulatory capital and deleverage.
3. The QBE USD 6.797% “old style” step-up Tier 1 security with a first call date of 1 June 2017 is considered excellent value and is currently offered at an indicative yield to call of 4.08% (which equates to a credit margin of circa 300bps). Alternatively the QBE USD 7.25% re-settable subordinated debt issue with a first call date of 24 May 2021 and final maturity date of 24 May 2041 is currently offered at a higher indicative yield to call of 5.08%, given the longer term to first call, however this equates to a lower credit margin of circa 295bps due to the higher ranking in the capital structure.
QBE released its 1H14 results last week and they were in-line with expectations, which is not surprising given the company provided an update/profit warning to the market just three weeks prior.
The key figures from the release were as follows:
- Net profit after tax $392m (1H13: $477m)
- Cash profit $416m (1H13: $590m)
- Gross written and net earned premium of $8.5bn (1H13: $9.4bn) and $6.9bn (1H13: $7.3bn) respectively
- Prescribed Capital Amount (PCA), which is the key APRA measure of regulatory capital, 1.56x (FY13 1.59x)
- Debt to equity ratio 38.4% (FY13: 44.1%)
While recent operational performance has been disappointing, QBE remains profitable with cash profit numbers that are ‘good enough for debt’ despite being a major disappointment to the equity market.
However, the results did come with a significant announcement for debt investors in the form of a capital plan. This is bordering on a game changer in our view as it is expected to see a sizeable improvement in regulatory capital and more importantly leverage.
The two most important statements in the 55 page results presentation were the following:
“Capital targets:
- Target PCA multiple of 1.7x-1.9x
- Target debt to equity of 25%-35%”
These are important for debt investors for two very important reasons.
Firstly, the achievement of those absolute targets would clearly result in an improvement of credit quality. The Prescribed Capital Amount as at 1H14 was 1.56x. Through equity raisings, asset sales and a partial IPO of the lenders mortgage insurance business, this crucial indicator of capital strength is expected to be over 1.8x by calendar year 2015 (as demonstrated by the chart below). This is a very meaningful increase.
The same events (and reduction in debt) are expected to see the debt to equity ratio fall from the current 38.4% at 1H14 to around 30% over the same short period. As recently as December 2013, debt to equity was 44.1%, demonstrating the considerable deleveraging that has been a focus of management.
The most significant and immediate of these announcements is the raising of $650m in equity which has essentially been completed already. Asset sales are expected this year and the partial IPO of the lenders mortgage insurance business at some point in 2015.
The second reason is the clear statement that QBE has made to the market that it is focusing on deleveraging and building capital and not looking for growth. QBE has been renowned in the past for acquisition-led growth and hence being more aligned to equity investors. These two announcements suggest QBE is becoming a debt centric, as opposed to equity centric company as it consolidates after years pursuing growth. Such visible and defined capital and leverage targets also give management a very clear focus.
As mentioned previously, operational performance has been disappointing but QBE remains profitable with cash profit numbers that are ‘good enough for debt’. However, the capital plan and sizeable improvements expected in the two key measures of PCA and debt to equity ratio are the real news for debt investors in QBE. Further, the improvement is expected to be rapid with the $650m equity raise essentially completed and a number of other asset sales planned for this year.
The QBE USD 6.797% “old style” step-up Tier 1 security with a first call date of 1 June 2017 is considered excellent value and is currently offered at an indicative yield to call of 4.08% (which equates to a credit margin of circa 300bps). Alternatively the QBE USD 7.25% re-settable subordinated debt issue with a first call date of 24 May 2021 and final maturity date of 24 May 2041 is currently offered at a higher indicative yield to call of 5.08%, given the longer term to first call, however this equates to a lower credit margin of circa 295bps due to the higher ranking in the capital structure. We continue to expect QBE to call these securities at first opportunity as they have consistently done in the past.
All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities. Both QBE USD securities mentioned in this article are available to wholesale investors only.