Upside For Suncorp From Regulatory Change

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Suncorp continues to skew its banking business away from investor and interest-only loans, revealing weak lending growth in retail in the March quarter offset by very low loan losses.

-Scope for modest improvement in mortgage growth versus peers
-Increase in impairments likely from Cyclone Debbie over the next quarter
-Expected to benefit from the imposition of the bank levy on the major banks
 

By Eva Brocklehurst

In an update on its banking business for the March quarter, Suncorp ((SUN)) has revealed weak lending growth in retail, offset by very low loan losses and a strong capital position. Impairment trends are benign and the company continues to positively skew its risk exposure to new loans by reducing interest-only and investor loans.

Ord Minnett reminds investors that Suncorp reported a 1.78% net interest margin in the first half but this should improve going forward because of the re-pricing of variable interest rates. Total lending assets are broadly flat. Bank capital is above the targeted range and the CET1 capital ratio is 9.19% as of March 31 versus an 8.5-9.0% target.

Ord Minnett remains cautious about the stock, given overall weak bank growth trends and the potential divergence in general insurance margins between Suncorp and Insurance Australia Group ((IAG)). Moreover, the fact the stock is trading around the broker's $14.11 target leads to a downgrade in the recommendation to Hold from Accumulate.

The main risks to the outlook the broker envisages include Queensland CTP margin pressures from regulators, industry-defying growth in NSW CTP (as Suncorp appears to the broker to have a more positive view on profitability versus the industry) and continued market share losses on profitable personal lines.

Mortgages

Suncorp has characterised the current environment for its banking division as offering modest growth amid challenging conditions. The company has made early changes in response to the signals from regulators on interest-only and investor lending.

The origination mix by loan purpose and repayment type is 70% owner occupied and 76% principal & interest. Lending growth was 0.3% in the quarter, comprising 0.4% for retail and -0.2% for commercial. The commercial outcome was driven by a -0.8% contraction in agribusiness.

With interest-only accounting for only 24% of the new home lending in the quarter UBS envisages scope for a modest improvement in mortgage growth, as APRA's new restrictions on interest-only origination constrain competitor activity.

UBS remains comfortable with sub-system growth at this point in the cycle. Still, a lower skew to investor lending and interest-only loans will also curtail the net interest margin benefits from re-pricing relative to peers.

Bad Debts

A lack of major bad debts in the quarter highlights earnings upside for Credit Suisse. The broker believes the recent increase in the share price is justified in the current environment of improving general insurance conditions, maintaining an Outperform rating.

The quarter disappointed the broker in regards to growth in the asset portfolio although the focus on profitable and sustainable lending practices is acknowledged. Suncorp maintains a limited exposure to inner city apartment developments and the resources sector.

On the subject of Cyclone Debbie the company has flagged an increase in hardship, home lending arrears and impaired assets over the next quarter and UBS suggests monitoring the construction and development exposures closely.

While these numbers are relatively small across the company's banking division the broker acknowledges it would prefer to see exposure in this area being reduced at this point in the credit cycle.

Going forward, Citi expects Suncorp will benefit from a home lending campaign in the June quarter and also from the banking levy announced for the five top Australian banks. Suncorp has said that the bank levy will go some way to realising a more level playing field versus the four major banks.

Impairments remain benign but consistent with Citi's forecasts and, while the impact from Cyclone Debbie has been muted so far, the broker notes the expectations for a rise in home lending arrears and impaired assets over the June quarter.

The broker expects the upside from regulatory/political changes will balance the soft growth in the bank book. As impairments are in line with expectations, Citi maintains a Neutral rating.

FNArena's database shows three Buy recommendations, four Hold and one Sell (Morgan Stanley, yet to comment on the update). The consensus target is $13.73, signalling -2.4% in downside to the last share price. Targets range from $12.00 (Morgan Stanley) to $14.45 (UBS). The dividend yield on FY17 and FY18 forecasts is 5.2% and 5.5% respectively.
 

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