After deterioration in many of the regional purchasing managers’ surveys, April’s ISM reading of 50.7 offers additional affirmation of slower growth in the manufacturing sector for the second quarter. The ISM averaged 50.8 in the final six months of 2012, so the latest print of 50.7 suggests that businesses are essentially about in the same shape as they were in the second half of last year. Still, of the 18 sectors represented in the report, 14 are still in expansion mode. One small bright spot in the report was the gain in new orders. New orders slowed to 51.4 in March but picked up to 52.3 in April and have now been in expansion mode for each of the first four months of the year. The ratio of new orders to inventories actually was at the highest level of the year, suggesting that manufacturers will have to commence restocking over the coming months.
5-Year Senior Credit spreads on the four major banks have fallen to their lowest levels today since May, 2010. Falling credit spreads have been cited as a key catalyst for the increase in share prices of the major banks from their 2011 lows, aside from other, more obvious factors like yield chasing and improving asset quality. Credit spreads as a measure of corporate default risk are highly correlated with wholesale funding costs for the major banks. In fact, as global financial conditions continue to improve, one can assume that financial credit spreads may continue to fall, netting lower funding costs and hence improved margins. Today, the fact that credit spreads on the four major banks are at 3-year lows weighs heavily in favour of share prices trading at record or multi-year highs.
The result was a little better than we thought because 1) the global markets result was particularly strong; and 2) The NIM decline was barely noticeable from 4Q12 to 2Q13. Depending on which income definition you wish to use (we use underlying income as the starting point), income growth was 2.4% from 2H12 to 1H13 and expense growth was 0.8%. In the jargon, there were positive jaws. CET1 was 8.2% but will fall after the payment of the dividend which was a healthy 73 cps. Asset quality improved with new impaired assets falling by 15% from 2H12 to 1H13. The new impaired assets for 1H13 were $1.6B. There was no change in the collective provision and the bad debt charge was $599M in 1H13. The performance of the APEA business continues to be intriguing. Cash profit fell by 11% from 2H12 to 1H13 but risk weighted assets increased by 13% (of which probably 5% was due to the introduction of Basel 3). The fall in profit was due to a doubling in the bad debt charge. We maintain our BUY recommendation but continue to rank it number 4 of the 4 major banks. We sense an increase in risk. In spite of this, the stock should go well today.
While there is increasing evidence of modest Chinese demand growth, with 0.5Mt fall in the 21Mt of non-mill steel inventories in mid-April, the extraordinary 775Mtpa production rate in early April has to pull back, and is expected to do so shortly. Mills are running low stockpiles, and preferentially restocking from cheaper port stocks, which are now at 70Mt vs last year’s average of 90-100Mt. Chinese iron ore production has also rebounded, India is about to add another 16Mtpa from Karnataka province, and RIO and FMG are also adding 50Mtpa and 20Mtpa respectively to the market in the current quarter. Construction demand in the US has improved, but not as much as expected. Japan is also expecting higher third quarter demand, arising from capital spending and infrastructure projects. Europe continues to be of concern, with improving weather unaccompanied by increasing construction demand.
Assurant (AIZ US Equity) is QBE’s largest competitor in the high-margin lenders placed insurance segment. Recent trends in lenders place insurance include regulator-enforced lower premium rates and a shrinking market due to a decline in mortgage delinquencies.
Moody’s lowered QBE’s credit rating 1 notch to Baa1. This move was foreshadowed in November 2012 following QBE’s downgrade, so yesterday’s announcement was not a surprise. The downgrade should not be an earnings event despite accounts indicating $1195M of debt will fall due by 31/12/13. If interest costs rise by 1% due to the downgrade this will add $12M to interest costs and this compares to our forecast FY13 NPAT of $1.4B. The bigger picture event is that QBE has significantly higher gearing levels than many of the larger US general insurers. The average gearing levels of 15 large US insurers was 26% at 31/12/12 compared to QBE’s 92%. This low gearing of competitors suggests there is an abundance of capital in the US market and that premium rate increases that took place in 2012 should be more subdued moving forward due to the oversupply of capital. The absence of meaningful rate rises will serve to anchor QBE’s insurance margin. YTD catastrophe claims may be a positive for the company in the US, as the March 2013 tornado damage has been lower than in previous years and the crop season is thus far better.
Gold has now fallen below or close to the price assumptions factored into the calculation of many mining company gold reserves, including Barrick’s 140Moz ($1500/oz) and Newmont’s 99Moz (A$1400/oz), while AngloGold Ashanti’s 74Moz are calculated using US$1300/oz gold, and Newcrest’s 87Moz at a more conservative US$1250/oz. We expect producers will not be in a rush to recast reserves given the recent gold price movements, and will maintain their schedule with the accounts, with revisions in July for the Australians, and January for the US. Relative to the last time there was a major fall in the gold price in the late 1990’s, gold producers have very little debt and almost no hedging, and therefore can manage their mines without having to negotiate with banks.
QBE was fined US$10m overnight in the US and has agreed to cut rates for some residential coverage as well as providing customer refunds. This action has come after a New York probe into kickbacks paid to banks on the back off force-placed insurance. Last month QBE dropped premium rates by 20% in Florida and we expect more rate cuts across all states in the US going forward QBE recorded claims costs of less than 20 cents for every dollar of force-placed premium it collected in New York from 2009 to 2011, the regulators found. That’s “substantially below” the expected 55 cents per dollar expected from filings QBE made with the department.
BOQ announced cash earnings of $120M for 1H13 and statutory profit of $101M. Total income increased by 1% from 2H12 to 1H13 and by 4% from 1H12 to 1H13. The net interest margin expanded by 2 bps with higher loan margins being offset by higher funding costs. The bad debt charge fell from $73M in 2H12 to $60M in 1H13. This comprised an $88M charge for specific provisions and a $28M release from the collective provision. Total provisions fell by $49M even though new impaired assets remain at high levels. The company maintains a strong capital position with CET1 at 8.7%.