John Neal’s announcement of a range of moves to shore up QBE Insurance Group’s balance sheet raises the question: what is he is fearful of?
With the foreshadowed 18 per cent decline in interim earnings to $US392 million, Neal also unveiled what QBE termed a "comprehensive capital plan".
That plan includes a $US750 million equity raising; the spin-out in a partial float of QBE’s lenders’ mortgage insurance business; the joint venturing of two of its Australian agency businesses; the sale of its US agency business and the completion of the sale of the group’s central and eastern European operations.
While QBE didn’t say how much it expects to raise from its asset sales, it did say that the combination of the equity raising and sales would reduce its gearing ratio (debt to equity) from 38.4 per cent to "comfortably within" a revised range of 25 per cent to 35 per cent. The equity raising will be used largely to repurchase and cancel $US500m of convertible subordinated debt.
The QBE LMI initial public offering is expected to occur next year. QBE said it would retain a "material" exposure to the business, which it said was highly profitable, but that the IPO would give the business a broader shareholder base and funding flexibility.
With the agency business joint ventures, a pre-condition is that QBE will enter a long-term agreement to retain the underwriting of business the agencies generate.
It is obvious that Neal wants to re-base QBE’s balance at a far more conservative level after a continuing series of earnings downgrades, the most recent of which emanated from the group’s Latin American workers’ compensation business.
The reason, therefore, for the capital plan might be as straightforward as a desire to make QBE’s balance sheet bullet-proof in case more legacy or left-field issues emerge. That would be understandable, given QBE’s unfortunate experience in recent years and the volatile environment in which it operates.
It might also, however, relate to the market’s suspicion that QBE’s complex balance sheet has disguised the real levels of leverage within it.
It can’t be just risk aversion. QBE plans to dial up the risk within its previously very conservative investment portfolio, increasing its risk asset exposure from 2 per cent to about 15 per cent over time in pursuit of increased yield and a better match between the duration of its $US31.4 billion of investment assets and its liabilities.
Neal said today the Australasian, European, Asia Pacific and Equator Re operations were currently performing in line with expectations and that QBE’s core business focus had now been defined. Neal has been trying to simplify the group, reduce its cost base, lower its risk profile and be more discriminating about the quality and pricing of the business that it underwrites.
The equity raising and asset sales add another dimension to that shift in QBE’s risk appetite. Whatever the motivation, they ought to create a more stable base for the group and greater insurance against the possibility of yet another unexpected and destabilising event.