Tom mcphail at hargreaves landsdown warns gilt issuance will increase pressure on the group
Research questioning the rescue package for Royal & SunAlliance (R&SA) has led Hargreaves Lansdown to urge investor caution on the life office.
Tom McPhail, pensions research manager at Hargreaves Lansdown, has serious concerns about the financial strength of the life office.
'Whether people should actually transfer out of the group will be down to individual circumstances,' he said.
Still, he warned, given the life office's heavy overweight position in fixed interest, further pressure could come from increased gilt issuance announced by the Chancellor in his pre-budget report last week.
'This will push down gilt yields and already most managers are predicting the top of the bull market in bonds,' McPhail said.
The comments follow the release of a research report from SchroderSalomonSmithBarney, which concluded Royal & SunAlliance's position is one of too much risk and too little capital.
Written by analysts, Andrew Crean and Kato Mukuru, who both remain very cautious on the company, it suggests the £300m earmarked by R&SA to support its UK life business might not prove sufficient given its low with-profit free asset ratio.
A review of R&SA's UK life funds by independent actuaries led the company to mention the possibility of having to commit £300m from shareholder's funds to its with-profits funds, the analysts said.
'Whether this will be needed or sufficient is hard to tell given the lack of data revealed to the market about this review. Investors have in essence been asked to take on trust that all is well,' Crean and Mukuru said.
The rescue strategy planned by R&SA, essentially a shrinking of its business, is also seen as having significant risks. The company has been showing signs of financial strain, Crean and Mukuru said, pointing to the transfer of its portfolio out of equities, which weakened the value base, and financial engineering to bolster the solvency level.
R&SA has said it will not use a rights issue to raise cash and intends move from a capital shortfall of £1.3bn at present to a £0.7bn surplus through shrinking the business by both disposal and discontinuance. However, Crean and Mukuru see significant challenges with this strategy.
The two analysts raise the question of whether the intended IPO of the Asian business of R&SA can be made at 1.5 times net asset value, given that the company averaged a return on earnings of 7.4% over the past six years.
Overall, they conclude, investment in Royal & SunAlliance carries significant downside risk connected with the company's uncertain operational outlook and its 'perilous capital position.'
Given these concerns, Crean and Mukuru have revised the target share price downwards by 20% from 120p to 100p.
They caution there is an upside risk to the gloomy scenario they portray but given the group's recent track record and 'it's ability to ride the cycle in times of relative prosperity', they suggest this not a likely scenario.
An R&SA spokesman rejected the claims made in the report and said the company has a full reserve under the FSA statutory basis.
'What everyone fails to pick up is that when our liabilities go up, as a result of interest rates or whatever, our assets also go up. The net charge is small,' he said.
The spokesman added the analysts are making assumptions based on incomplete information. The sale of its US business and the IPO of its Asian interests should be complete by the first half of 2003 and will provide two-thirds of the capital release the company is looking for, he said.
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