Fitch Affirms QBE's IDR 'A-'; IFS at 'A+'; Outlook Negative

Fri Aug 22, 2014 4:05am EDT

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(The following statement was released by the rating agency) SYDNEY, August 22 (Fitch) Fitch Ratings has affirmed QBE Insurance Group Limited's (QBE) Long-Term Issuer Default Rating (IDR) at 'A-', and affirmed its subsidiaries' Insurer Financial Strength (IFS) ratings at 'A+'. The Outlook is Negative. A full list of rating actions can be found at the end of this commentary. KEY RATING DRIVERS The affirmation of QBE's ratings reflect its solid and improving capital ratios, improving financial leverage ratios, a historically strong underwriting performance supported by sound aggregate management and a comprehensive reinsurance program, and a low risk investment portfolio. Offsetting these strengths is Fitch's uncertainty around the future supportability of the group's significant level of goodwill (USD3.9bn at end-2013), and the potential for financial flexibility to be constrained as a result of further impairments, operational underperformance and weak earnings. The group is targeting stronger capital and financial leverage ratios which will help build buffers into the group's ratings that have previously been absent. Coverage of the regulatory prescribed capital amount (PCA) was a solid 1.56x at end-June 2014 (1H14), and will strengthen as a result of debt and equity initiatives. Moreover, the composition of the capital base will improve as USD750m of new ordinary equity will retire USD500m of subordinated debt, and USD700m of new Tier 2 subordinated debt will retire USD400m of senior debt. QBE is targeting a higher PCA range of 1.7x to 1.9x, and outside of the debt and equity initiatives, plans to achieve this through the sale of US and Australian underwriting agencies and a partial float of QBE Lenders' Mortgage Insurance Limited. Fitch and the Australian regulator do not give any capital benefit to the goodwill associated with the agencies, so the monetisation of this will strengthen Fitch's assessment of capital and Australian regulatory capital ratios. QBE's financial leverage, measured by adjusted debt to total capital, was 26% at 1H14, which is slightly above the mid-point when compared to Fitch's median criteria guideline for an 'A' rated insurer. However, the size of the impairment in 2013 and materiality of QBE's remaining goodwill means Fitch also places a greater emphasis on financial leverage excluding goodwill. Under this calculation the financial leverage was 34% at 1H14 which is below Fitch's 'A' median criteria guideline. QBE has traditionally operated with higher financial leverage than similarly rated peers, and a track record of strong earnings and underwriting performances have provided the group good access to equity and debt capital markets, when required. However, in Fitch's opinion further significant underperformance could erode QBE's historically strong financial flexibility, which would not be consistent with an 'A+' rating. Measured by the combined ratio (CR), the group's underwriting performance has trended lower and was 96% in H114 (end-2013: 98%) against a five year average of 94% to end-2013. This remains comparable to similar and more highly rated peers, and compares favourably against Fitch's median criteria guideline of 103% for an 'A' rating category. QBE is forecasting a stronger underwriting performance in H214, and a CR for 2014 of between 95% and 96%. H114 included a one off USD170m in reserve strengthening, mainly from the group's Argentinian workers compensation business. Fitch considers it important for QBE to generate above average underwriting results to support earnings and interest coverage, given the group's high level of intangibles and low yielding, low risk investment portfolio. The latter is dominated by highly rated short duration cash and fixed income securities, and in the current low interest rate environment, the total investment yield has fallen from 5.5% (running yield 2.6%) in 2009 to 2.6% (running yield 2.1%) in 2013. On an annualised basis, QBE generated a 2.7% and 2.1% total investment and running yield, respectively in 1H14. EBITDA interest coverage remains weak, increasing to 4x in 1H14 from a low of 3x in 2013, and has averaged 6x over the five years to end-2013. Lower financial leverage and stronger operating performance would result in higher interest coverage ratios. However, the protracted nature of the group's problems results in a residual level of uncertainty around future operating performance. Finance costs rose from USD191m in 2009 to USD345m in 2013 as the group used higher leverage to finance acquisitions but had declined to USD150m in 1H14 (1H13: USD168m). RATING SENSITIVITIES The key rating triggers that could lead to a downgrade include further goodwill impairments, indicating more underlying operational problems and a failure to achieve an EBITDA interest coverage of 5x in 2014. In these circumstances, Fitch would place a greater emphasis on financial leverage excluding goodwill and under this calculation; this ratio would not be in line with an 'A' rated insurer. The key rating triggers that could result in a revision of the Outlook to Stable include substantial progress toward a return of EBITDA interest coverage of 7x and reserve redundancies. The agency includes the impact of movements in the central estimates, risk margins and discount rates in assessing reserve adequacy. Fitch would expect to see these occur without any weakening of capital or financial leverage ratios. List of rating actions: QBE Insurance Group Limited (QBE): Long-Term IDR affirmed at 'A-'; Outlook Negative; USD600,000,000 senior unsecured debt affirmed at 'BBB+'; GBP300,000,000 perpetual preferred securities affirmed at 'BBB-'; USD1,000,000,000 subordinated debt affirmed at 'BBB-'; and GBP325,000,000 subordinated debt affirmed at 'BBB-'. QBE Insurance (Australia) Limited: IFS rating affirmed at 'A+'; Outlook Negative. QBE Insurance (International) Limited: IFS rating affirmed at 'A+'; Outlook Negative. QBE Insurance Corporation: IFS rating affirmed at 'A+'; Outlook Negative. QBE Insurance (Europe) Limited: IFS rating affirmed at 'A+'; Outlook Negative. QBE Re (Europe) Limited: IFS rating affirmed at 'A+'; Outlook Negative. QBE Hongkong & Shanghai Insurance Limited: IFS rating affirmed at 'A+'; Outlook Negative. QBE Reinsurance Corporation: IFS rating affirmed at 'A+'; Outlook Negative. Equator Reinsurances Limited: IFS rating affirmed at 'A+'; Outlook Negative. Contacts: Analysts John Birch Director +61 2 8256 0345 Fitch Australia Pty Ltd, Level 15, 77 King Street, Sydney, NSW 2000 Tim Roche Senior Director +61 2 8256 0310 Committee Chairman David Prowse Senior Director +44 3530 1250 Media Relations: Leni Vu, Sydney, Tel: +61 2 8256 0326, Email: Leni.Vu@fitchratings.com. Additional information is available on www.fitchratings.com Applicable criteria, "Insurance Rating Methodology" dated 15 August 2014, are available at www.fitchratings.com. Applicable Criteria and Related Research: Insurance Rating Methodology here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S FREE WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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