The insurance companies, and the banks, have received less investor attention and appreciation than we would have thought pre-reporting season.
Starting with the insurance companies, all of them (below, QBE, MPL, SUN) are major beneficiaries of higher rates.
They differ in their insurance exposure (QBE is international, insures a more diversified commercial set of customers, SUN/IAG are a domestic duopoly focused on home and motor, MPL is a local private health insurance company) and thus they are not all the same underlying insurance risk or factor bet.
For QBE, the mark-to-market losses are less relevant for an approach that is typically “hold to maturity”, and in any case the higher running yields moving forward highlight just what an earnings boost the might get.
All you need to do is eyeball recent history to get a sense of what the earnings kicker could look like.
It is the same for SUN, and MPL (not shown).
Premiums are growing strongly, as insurance companies attempt to a) offset inflationary impacts and b) price the extreme weather conditions more appropriately, to ensure a better, healthier insurance underwriting outcome.
And, that higher premium growth is indeed translating into higher underwriting profit, after years of underwhelming, under-priced outcomes.
It is a similar story for the banks.
For many years falling net interest margins (the key measure of bank profitability) were a function of rates globally drifting towards, and eventually anchoring at, zero, which weighed on bank share prices.
Now, we have the opposite dynamic, rates are rising to combat inflation, and bank leverage to rates is strong.
ANZ at their last trading update noted underlying NIMs were up 6bps, with margins improving across all business units.
CBA has likewise noted that each 25bp hike by the RBA translated into NIM expansion of 4-5bps. Based on the outlook for rates, that is a material driver of profits.
The banks are also vastly better capitalised than they used to be, which, as mentioned earlier, was a drag on returns as equity buffers increased, but, has now reached a new, higher equilibrium, reducing the drag moving forwards, but resulting in a much safer system overall.
This was the regulators goal, to reach “unquestionably strong” levels of capitalisation for systemically important entities.
The prospect of rising bad and doubtful debt charges are a threat, as households may well struggle under meaningfully higher mortgage rates, however a) the above leverage story reduces the risk to the banks relative to say gearing levels from the early 2000’s, and b) what does that imply for the other sectors, such as consumer discretionary?
The banks would have claimed the higher share of wallet, we’d suggest, potentially outperforming other sectors who are experiencing a shrinking share of consumer wallets.
Banks and insurance companies may be a “little boring”, but the yields, the net profit tailwinds, the solid balance sheets all make for a fairly attractive allocation, in our mind, one that the market seems surprisingly uninterested in.
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