good bank bad bank

Good bank, bad bank
Tony Boyd
http://www.businessspectator.com.au/bs.nsf/Article/Good-bank-bad-bank-pd20090417-R6U4B?OpenDocument&src=sph


The pressure is rising on Suncorp to publicly reveal the implications of splitting its banking business into a good bank and a bad bank, including the impact on capital.

Suncorp's obligations under the continuous disclosure rules will be the focus of attention, after Deutsche Bank analyst James Coghill published a report suggesting Suncorp could free up $1.6 billion in capital over the next four years.

The detailed analysis of Suncorp's good bank-bad bank strategy contains many assumptions on the part of the author, but it also appears to be particularly well informed.

Suncorp's shares are now trading at a 45 per cent premium to the recent retail entitlement offer price of $4.50. Coghill rates the stock a buy and a yesterday lifted his 12-month price target from $7 to $8.50.

The good bank-bad bank strategy is being driven by the capital dynamics in regional banking canvassed by Alan Kohler (Bleeding regional banks, April 17) and Stephen Bartholomeusz (The regional banking handicap, April 16).

Suncorp said in February at its half-year results that following a strategic review it had categorised its loan book into core and non-core, which is another way of saying good and bad.

The core lending is the bread and butter of regional banks that tends not to cause large bad debts. It includes personal customers, small business, agribusiness, commercial (or SME) banking, traditional middle market development finance and property investment.

The non-core lending was transaction-driven activity that is not viable when capital is scarce and the economy is in recession. It has also tended to have been beyond the credit assessment skills of many regional bankers. It includes corporate banking, corporate property and lease finance.

Suncorp's chief financial officer and now acting chief executive Chris Skilton said in February that it was difficult to work out the balance sheet impact of running off the non-core assets.

Coghill says the non-core loan book totals $13.5 billion.

That figure suggests Suncorp might actually be withdrawing more lending capacity from the domestic market than the much trumpeted exodus by foreign banks.

The bad bank run-off will certainly have implications for property lenders in Queensland trying to roll over their finance commitments.

According to Coghill's numbers the non-core assets are split as follows: corporate $3.6 billion, development finance $3 billion, property investment $4.65 billion and lease finance $2.2 billion.

There are two big reasons why the non-core lending book is not worth having. As Coghill says, the non-core book is 100 per cent risk-weighted for capital purposes and it is dominated by wholesale funding. Less than 10 per cent of non-core is funded by Suncorp's depositors while 50 per cent of its $55.8 billion core loan book is funded from retail deposits.

The difference in funding means that the non-core loan book has margins that are 40 basis points less than the core loan book.

Suncorp has a special team managing the run-off. It has effectively created two separate banks.

Skilton warned in February that “the near term the ability for us to make significant inroads into the non-core portfolios will be limited.”

Over the longer term there could be a significant release of value as the bad bank runs off the balance sheet.

Coghill says the wild-card is the possibility of further write-downs in the non-core loan book. He says bad debts would have to be $1 billion higher than his current forecast of $1.27 billion before another equity raising would be needed.

Using conservative valuations of Suncorp's insurance business relative to IAG, Coghill concludes that the market is valuing the Suncorp banking business at about $1 billion or about $1.5 billion less than the current book value.