Sensible Suncorp cuts its losses

It says something about the environment that Suncorp’s Patrick Snowball was prepared to take a loss of between $470 million to $490 million to get the "monkey off our back".

As he said today, the sale of $1.6 billion of assets, a majority of them non-performing, out of Suncorp's 'bad bank' or, as it prefers, its non-core portfolio, is a huge milestone for the group albeit one that comes at a significant cost.

For four years Suncorp has carried the burden and the distraction of the non-core portfolio, which was separated, capitalised and match-funded in 2009 after the global financial crisis, exposed to $18 billion of dodgy loans that brought the group to the brink of selling itself to ANZ Bank on distressed terms.

Through natural run-off and some previous sales that portfolio has been reduced to $2.8 billion of assets and after today’s sale of $1.6 billion of those loans to Goldman Sachs, which has yielded 60 cents in the dollar of their current face value, Suncorp will be left with just over $1.2 billion of assets within its non-core portfolio.

With further anticipated run-off and individual loan sales, the group expects the residual portfolio to be reduced to only about $500 million by July.

Despite the apparently heavy losses, the sale is sensible and has produced a better outcome than most in the market would have anticipated, given that similar sales by other lenders have been done at 30 to 40 cents in the dollar. Strong competition from Macquarie and Blackstone in a process overseen by its adviser, Greenhill, helped Suncorp achieve a very good result in the circumstances.

Suncorp had previously tried to offload the portfolio – it first tried back in 2009 – but it was too large and the indicative offers received would, had they been accepted, blown up its bank. The terms of today’s sale are far more digestible.

Apart from Snowball, whose mantra is "simplification" and who has done exactly that to the group since becoming chief executive in 2009, the most relieved party that the legacy portfolio has been largely exited will be the Australian Prudential Regulation Authority.

With the economy deteriorating as the resources boom fades no regulator (or chief executive) would want a regional bank to enter the period ahead with the best part of $3 billion of risky property and corporate loans sitting on their books.

The losses crystallised by the sale might be significant but they de-risk the group and remove the distraction of what Snowball described as a portfolio that was not homogenous either in terms of the types of assets or the geographies involved.

Suncorp did have nearly $500 million of capital dedicated to the non-core portfolio so that will be wiped out by the sale but the removal of $1.6 billion of assets via the transaction and the other $400 million to come before the end of July will shrink Suncorp’s balance sheet and the net impact on its regulatory capital ratios should be negligible. Getting rid of most of the term funding for the non-core portfolio should also be a positive.

Given that the market had effectively placed no value on the capital set against the non-core portfolio (and may well have imputed additional losses beyond the $500 million) the sale shouldn’t have a materially negative impact on the group’s share price, which was down slightly in a weaker market today.

The Suncorp board, however, was clearly sensitive to the potential reaction from smaller investors, with chairman Ziggy Switkowski saying that directors would consider paying above its target dividend payout range of 60 per cent to 80 per cent of cash earnings for this financial year, where the earnings will be impacted by the loss on the sale of the portfolio. He also said any surplus capital would be returned to shareholders.

The de-risking of Suncorp returns it to what it always should have been, a regional bank funded mainly by retail deposits making mainly low-risk loans to individuals and small and medium-sized businesses rather than the loans to the Babcock & Browns of the corporate world and the funding of big speculative property developments that brought it undone.

For Goldman, the purchase of the portfolio makes some sense. It can borrow very cheaply in this environment and the 40 per cent discount on the book value of the loans provides both insurance and a lot of potential upside if it manages the individual exposures and their run-off effectively.