Weekly Broker Wrap: Oz Economy, Insurance, Banks And A-REITs

This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: IAG

-Confidence hit from equities matters
-Returns peak for insurers
-Bad debts on the rise?
-Shift in A-REIT performance
 

By Eva Brocklehurst

Economy

Is Australia's economy in recession? UBS suspects that June quarter data may "pay back" the upside surprise in the March quarter GDP, which grew 0.9% quarter on quarter to be up 2.3% over the year. Exports fell in the June quarter and inventories are expected to be a drag, given the "cliff" in capital expenditure plans that is emerging.

The broker's GDP forecasts do not meet the accepted definition of a recession – two consecutive quarters of negative real GDP – but suggest a higher than normal risk of contraction in at least one quarter for the rest of 2015.

June quarter nominal GDP is forecast to contract 0.3%, dragged down by a collapsing terms of trade causing record low wages and flat corporate profits. Still, rather than a broad downturn across industries, UBS suspects would be more likely reflecting the timing of an intense reduction in capex this year, ahead of a boost from the full ramp up of LNG exports in 2016.

The risk that confidence is battered by the recent share market slump matters substantially, because growth is reliant on maintaining consumer and business confidence. Hence, UBS suspects the risks to GDP are on the downside.

Insurance

The market conditions for general insurance continue to worsen. Macquarie observes the slowest growth in gross written premium since 2005. APRA statistics reveal commercial is down 1.6% for the year to June 2015 while personal is up 1.9%. The weak June quarterly data is a poor sign for the sector, in the broker's opinion. Rates continue to fall and volumes are flat, so as insurance asset values increase this will squeeze margins.

Macquarie believes returns have peaked for Insurance Australia Group ((IAG)), Suncorp ((SUN)) and QBE Insurance ((QBE)) in the absence of further cost cutting. The overall market size in Australia is relatively flat so new entrants are continuing to make inroads and place pressure on incumbents. In response, Suncorp and IAG have turned to increased reinsurance to normalise returns.

Overall, the APRA data was slightly more positive than Credit Suisse had assumed. The June quarter for commercial property showed the first positive growth quarter since December 2013. Industry gross written premium grew 0.7% and the slowing was attributable to products other than commercial. Credit Suisse agrees IAG and Suncorp are losing market share.

The broker suspects current cost cutting initiatives are not enough to support margins at current levels. Credit Suisse prefers Suncorp over IAG and QBE.

Banks

Leading indicators of a deterioration in asset quality are emerging. Commentary from ANZ Bank ((ANZ)) causes the most concern at UBS. The bank indicated it was witnessing higher collective provisioning charges because of balance sheet growth coupled with heightened risk relating to agriculture and resources. To UBS the improvement in stressed exposures appears to be at an end.

In the past, higher corporate credit losses usually followed periods of elevated business lending and loose underwriting. UBS suspects, while these conditions are not apparent on the surface, a dive into the banks' reports shows total corporate exposures have grown 7.0% over the past five years. The broker remains concerned about the outlook for bad debts.

Any official rate reductions from the Reserve Bank, especially if US rate hikes are delayed, should allow for further re-pricing of the net interest margin. Still, UBS prefers Westpac ((WBC)) and Commonwealth Bank ((CBA)) given strong asset quality and greater re-pricing leverage.

Credit Suisse considers the backward-looking data for the banks from the reporting season reasonably benign, although acknowledges asset quality stresses are emerging. This is notable in pockets: in mining, NZ dairy exposures and agriculture on both sides of the Tasman.

Impaired ratios have declined although loss rates edged up. Collective provision coverage is flat for a second successive quarter, although, the broker acknowledges, it edged up for ANZ and National Australia Bank ((NAB)).

In sum, revenue growth for the banks has struggled and system business credit growth is soft, while major bank margins continue to edge lower. The broker suspects the bulk of capital raisings are complete although Westpac is expected to undertake further underwriting of the dividend reinvestment plan.

A-REITs

Australian Real Estate Investment Trust (A-REITs) returns contracted 2.6% over the latest reporting week, weaker than the overall equity market. The best results to date, in Credit Suisse's view are GPT Group ((GPT)), Stockland ((SGP)) and Mirvac Group ((MGR)).

Credit Suisse expects that sector earnings should remain stable over FY15-17 with growth of 4.4% and a shift in composition. Westfield ((WFD)) is expected to accelerate earnings the most, to 4.0% from 1.9%, while Dexus Property ((DXS)) and GPT are expected to decline to 5.7% from 9.2% and 2.9% from 6.0% respectively.
 

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