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Morningstar | Suncorp Bank’s 3Q19 Update Uninspiring. FVE AUD 14.50 Unchanged

No-moat-rated Suncorp Group’s uninspiring third-quarter fiscal 2019 banking division results did not surprise. Sound asset quality and funding capacity were highlights, offset by a muted outlook on lending growth. There were no material developments that altered our long-term view of the regional bank and parent Suncorp Group. Nevertheless, pending the absence of any natural disasters in the near term, we would expect a slightly more positive outcome for Suncorp Bank’s fourth-quarter results, especially given short-term wholesale funding costs continued to trend downwards. Our AUD 14.50 fair value estimate remains intact, and the stock screens as fairly valued at current prices. Suncorp releases fiscal 2019 results on Aug. 7, 2019.

Suncorp Bank’s lending portfolio continues to struggle. Momentum is soft with total lending down by 0.5% over the quarter, which translates to growth of 1.0% on a trailing-12-months, or TTM, basis. Both metrics lag the system, which grew 2.5% over the quarter and 6.0% over the past twelve months. This underperformance was led by a contraction in the important housing loan book, which fell 0.7% over the quarter and grew marginally by 0.8% on a TTM basis (versus growth of 0.5% over the quarter and 3.5% TTM across the system). A combination of price-driven competition and a continued slowdown in demand for credit weighed on the performance of the housing book, which is overweight in the Queensland and New South Wales housing markets.

Nevertheless, we were encouraged by strength in the business book, which rose by 0.3% over the quarter and 2.8% over 12 months. In particular, the commercial portfolio grew by 0.2% over the quarter, while the agribusiness portfolio impressed with 0.4% growth over the same time period despite significant weather events. Suncorp Bank’s capital positioning remains robust, and importantly loan quality is outstanding.

Looking at the near-term future, Suncorp has guided towards continued growth in the business book, underpinned by an expected improvement in agricultural conditions and a new AUD 3 billion lending commitment. Disappointingly, home lending conditions are expected to remain soft due to continued tightening of serviceability and lending standards across the industry. Regardless, we remain optimistic in Suncorp Bank’s ability to grow customer numbers and loan balances over the long run. We forecast through-the-cycle loan growth of around 3% per year (versus five-year historical average of 4%), underpinned by a simplified origination process, growing customer retention and an increasing geographic diversification.

We like the quality of Suncorp Bank’s lending portfolio, which sits at healthy levels due to prudent risk management. As at March 2019, the housing loan book remains conservatively positioned with 72% owner-occupier exposure, 79% principal & interest and only around one fifth with a loan/value ratio of above 80%. Furthermore, the commercial portfolio is well-diversified and weighted towards lending facilities below AUD 5 million. While nonperforming loans ticked up 2.5%, we believe there is no reason to panic as the tick-up was mainly attributed to weather events in Townsville and north-west QLD, and that increases in arrears due to flood events have historically been temporary.

The bank’s loan loss rate was unsustainably low at zero due to a AUD 7 million collective provisioning write back. This is significantly below the bottom end of the bank’s expected loan loss operating range of 0.10%-0.20%, and the lowest of major and regional peers by a long stretch. We reduce our fiscal 2019 forecast loan loss rate of 2 basis points, equating to a bad-debt expense of AUD 12 million.

We are encouraged by continued progress in Suncorp Bank’s funding and liquidity capacity. The bank’s loan growth is funded mainly via customer deposits, a source of cheap funding. Based on banking statistics by Australian Prudential Regulation Authority, or APRA, Suncorp Bank’s household deposit growth for the 12 months to March 2019 was strong at 6.7%, exceeding the overall system growth rate of 5.2%. The bank also completed an offshore senior unsecured debt issue of USD 500 million over the quarter. While it is targeting "above system" growth in at-call deposits in the fourth quarter (which should be supported by investments to enhance customer experience), our through-the-cycle deposit growth forecast of 5.0% per year remains intact given the outlook for deposits is currently tied to an already-bottoming official cash rate and a retracting deposit market.

The fall in the 90-day Bank Bill Swap Rate helped alleviate some wholesale funding costs, but we think this benefit will be offset by ongoing pressure from price-led mortgage competition in the near term. Until we see renewed pricing power, increased demand for credit and stable funding costs, our through-the-cycle net interest margin assumption sits at 1.80%--the bottom end of management’s guidance.

The common equity Tier 1 ratio of 9.1% exceeds its target range of 8.5% to 9.0% following the payment of the interim fiscal 2019 dividend. While the common equity Tier 1 ratio trails the advanced accredited four major banks, Suncorp Bank’s capital levels continue to satisfy APRA’s lower capital threshold for banks utilising the standard risk weighting methodology. The net stable funding ratio of 112% at the end of March sits comfortably above the internal target of 105%.