Snowball effect moves the monkey

You could fill a fairly fat phone book with the names of chief executives who have claimed erroneously that their companies were at a historic and positive turning point, but Suncorp boss Patrick Snowball's claim on Wednesday that the group has made a "break with the past" is likely to prove correct.

You could fill a fairly fat phone book with the names of chief executives who have claimed erroneously that their companies were at a historic and positive turning point, but Suncorp boss Patrick Snowball's claim on Wednesday that the group has made a "break with the past" is likely to prove correct.

In June he announced that he had sold a $1.6 billion debt portfolio in Suncorp Bank to Goldman Sachs at a price of 60¢ in the dollar.

The bank posted a post-tax loss of $632 million in the year to June after importing the book loss on that transaction, and Suncorp's bottom line-profit fell by 32 per cent to $491 million.

The loss in the banking business flows from a genuinely transformational deal, however, and the better guide to the group's performance and capacity to reward shareholders is its 19.3 per cent rise in core earnings to $1.2 billion.

Snowball inherited an $18 billion "bad bank" loan portfolio when he took charge of Suncorp in September 2009. It was a legacy of aggressive commercial real estate lending ahead of the global crisis, and the problem loans equalled about 20 per cent of group assets.

In a fire sale they might have fetched 30¢ in the dollar, generating a life-threatening loss for the group, and Snowball therefore stuck with the plan he had inherited, to wear down the bad debt mountain over time: he had cut it to $2.8 billion by the time he struck the $1.6 billion deal with Goldman in June.

The residual portfolio was $735 million on June 30, $452 million of it performing, and the balance provisioned. Snowball says it will be down to less than $100 million by June, 2014, and special dividends are becoming the norm as capital that was tied to the "bad bank" loan book comes free.

Suncorp declared a special dividend of 15¢ a share a year ago, and on Wednesday boosted its regular annual payout by 15¢ to 55¢ a share, and announced a 20 cents a share special payout worth $257 million. There's still $747 million of excess capital on the balance sheet, so more special payouts are likely.

The total dividend was $965 million, almost twice as much as Suncorp's bottom-line profit of $491 million. It is a more comfortable 78 per cent of the "core earnings" of $1.2 billion, however, and the regular payout of 55¢ a share is 59 per cent of core earnings - slightly below Suncorp's target range of 60 per cent to 80 per cent.

Snowball called the bad loan mountain a monkey on his back while he was dealing with it. Now the monkey has moved on, and the focus is on the profits he is extracting from the insurance businesses and the "good bank" that remain. He aims to lift the group's return on equity (ROE) to at least 10 per cent by 2014-15, and is closer than he appears to be, even though one of his divisions is underperforming.

Based on the reported earnings of $491 million, Suncorp achieved an ROE of only 3.5 per cent in the June year, down from 5.2 per cent in 2011-12. The core earnings of $1.2 billion equalled an ROE of 8.8per cent and two out of three divisions are already hitting the 10 per cent-plus target.

Suncorp's general insurance business boosted net earnings by 79 per cent from $493 million to $883 million, and returned 10.4 per cent. Stripped of the "bad bank" problem Suncorp's banking unit earned an unchanged $289 million in the year - good enough for a Snowball-satisfying 10.5 per cent return, although still well short of the 15.6 per cent average ROE the Big Four banks delivered last year.

Life insurance is Suncorp's problem child. Like AMP and other life companies, it coped with higher claims and higher customer churn rates that exposed over-optimistic policy prices. Rising yields on government bonds that are the benchmark for the discount rate Suncorp applies when it works out its liability for future claims also created a a $60 million "mark-to-market" charge, and the insurance division's overall profit plunged from $251 million to $60 million, and return on equity of just 2.2 per cent.

The mark to market adjust is noise, basically, albeit noise that will continue for some time if yields edge higher as most expect. Suncorp posted a $105 million mark to market gain using the same calculus in 2011-12 because bond yields were falling then.

The 10 per cent ROE target is nevertheless a very daunting target for the life division. Snowball says it will lift revenue by directly selling and cross-selling product, and lift profitability as his rationalisation and simplification of Suncorp's processes delivers economies of scale and savings.

Sustainable earnings of about $270 million a year would be needed to generate a 10 per cent return on existing equity.

That won't happen on the timetable he has set. He needs to also cut the life business' capital intensity, too.

Earnings of, say, $200 million a year would return 10 per cent if capital employed was $700 million or 25 per cent lower, for example.

Snowball is confident he can get the job done, but it won't be easy.

mmaiden@fairfaxmedia.com.au

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