Suncorp Suffers From Weakening Credit Quality

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By Chris Shaw

Queensland bank-insurer Suncorp-Metway ((SUN)) yesterday updated the market on its trading for the first quarter of FY11, the results showing reasonable performance with respect to core bank trends, but with more mixed results elsewhere.

As JP Morgan notes, the market update indicated growth in mortgages is returning to system levels, with management confident the improved momentum can carry on into next year. Margin performance has also been solid and funding and capital levels remain strong, while within the non-core bank the run-off of non-core assets is now $2.3 billion ahead of schedule.

The disappointing element of the update for RBS Australia was an increase in absolute impaired non-core bank assets of $325 million, the broker attributing this to the inclusion of the the group's exposure to Austexx, the parent company of DFO, in the impaired category.

There was also an uptick in bad and doubtful debts generally to $92 million for the quarter, something RBS saw as disappointing given recent trends had been more positive. The broker expects bad and doubtful debt charges will remain volatile on a quarterly basis, but BDDs should continue to trend lower.

One issue causing some concern for UBS is the update by Suncorp-Metway implies while loan growth trends remain solid, there has been a weakening in credit quality. Credit Suisse also picked up on this, at the same time noting the update suggests an expected realisation of operational improvements in the general insurance business is coming more slowly than had been anticipated.

The other news to come from the trading update was Suncorp-Metway has sold Tyndall Investments to Nikko Asset Management, with the deal to be completed early in 2011. Credit Suisse notes Suncorp-Metway will receive $80 million in cash upfront, a $5 million access payment paid over four years and an additional $30 million after three years if an option to extend a commitment to Nikko is exercised.

On Credit Suisse's numbers, the sale will generate a loss of around $30 million, but the option deal could offset some of this loss in the future. JP Morgan suggests the Tyndall assets were sold too cheaply, though the positives are the sale is not particularly material for the group overall and it does help simplify the life insurance operations.

Post the trading update there have been some minor revisions to earnings forecasts, UBS cutting its earnings per share (EPS) forecast by FY11 by 4% to reflect higher bad debt charges. The broker is now forecasting EPS of 65c this year and 81c in FY12.

Credit Suisse in contrast cut its EPS forecasts by less than 1% in both FY11 and FY12 to 90.6c and 106.6c respectively. The broker remains well above the market with its forecasts, the FNArena database showing consensus EPS estimates for Suncorp-Metway of 73.9c in FY11 and 89.7c in FY12.

Only Credit Suisse has changed its rating post the trading update, downgrading to a Neutral rating from Outperform previously. The change is a valuation call, the broker noting Suncorp-Metway has outperformed the S&P/ASX200 Accumulation Index by 8% since its full year profit result in August.

Overall, the FNArena database shows Suncorp-Metway is rated as Buy and Hold three times each and Underperform once, this courtesy of Macquarie. Valuation is an issue for Macquarie, the broker's other concern being emerging negative anecdotal evidence on the health of the Queensland residential property management.

Rising interest rates could exacerbate this, so Macquarie retains its negative view post the trading update. Citi in contrast continues with its Buy rating, noting long-term trends remain favourable and Suncorp-Metway continues to execute its simplification strategy.

RBS Australia agrees, pointing out at current levels Suncorp-Metway is trading at more than 11% below its own price target of $10.43, which implies good value. The consensus price target according to the FNArena database stands at $10.01, which is little changed from prior to the trading update.

Shares in Suncorp-Metway today are weaker in line with the broader market and as at 2.10pm the stock was down 17c at $9.26. Over the past year the shares have traded in a range of $7.56 to $9.76 and the current share price implies upside of a little more than 8% to the consensus price target in the FNArena database.

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