David Foster, group executive banking, Suncorp, interviewed by Tony Boyd of Business Spectator.
Tony Boyd: David, you've announced you're shifting about $3.3 billion in property financing portfolio assets into your non-core bank. Could you just explain what is core and what is non-core?
David Foster: Sure. We went through an exercise late last year which looked at what happened in the financial market place over the previous year or so and the strengths and opportunities of the business to take that business forward. If I look back at the history of the group with Metway and QIDC we had a lot of strengths and core capabilities in areas such as property finance and so forth. As opportunities presented themselves, we grew those books in the last few years, given that there was a cheaper wholesale funding available and capital wasn't a constraint.
Clearly, the world's changed in the last 12 months. That necessitated this review and that was done on a few dimensions; we looked at the cost of funding and how long that would likely last into the future; from a competitive perspective we looked at areas that we felt that we could continue to compete and prosper in; and from a customer pricing and profitability perspective. In addition we looked at the risk profile of the business going forward. The result of that is essentially we moved some of our businesses into what we call non-core. I would stress that it wasn't credit criteria that determined the composition of core and non-core. The non-core was essentially made up of those types of businesses that had a more transactional relationship with us as opposed to core relationships. They included corporate banking, corporate property and intermediated equipment finance.
Boyd: So it wasn't a good bank, bad bank split?
Foster: No, absolutely not. The core bank includes retail banking, SME and agribusiness. Through a normal credit cycle we will have, credit exposures and bad debts through that part of the business and likewise in our non-core portfolio. You know a significant part of that non-core business is absolutely pristine from a credit perspective. But clearly the make up of that portfolio tends to be 100 per cent risk-weighted type assets in corporate and a number of the property sectors and therefore does have a different risk profile, but it is clearly not a bad bank.
Boyd: One of the ratings agencies said that Suncorp really has a traditional, regional bank and a wholesale bank. Could you just talk about the traditional regional bank? What's special about that or what's different about that?
Foster: Well, I think the make up of that core bank is predominantly our retail business, our SME and our agribusiness. We've got a long history in each of those segments and have been quite successful. We've got industry leading in the top couple in terms of customer satisfaction rankings within those portfolios and likewise we're the leader in terms of main financial institutions score for those particular retail segments.
There's a particular part of the market that our value proposition and service proposition really appeals to and there is now an opportunity created via the movement of our main competitors in that space being St George and BankWest into the major banks. They have essentially left a white space for us to really grow into to and to capture customers that like our value proposition and the type of service that's offered by a regional bank. It has a lot of appeal to consumers in that segment and clearly we've got a lot of capability to deliver to in those segments and a proven track record.
Clearly, a lot of that capability's been built in Queensland, but over the last six months or so we've expanded that into Western Australia where we've opened up six branches in the last six months and got off to a very strong start over there with growth rates well in excess of our expectations.
Boyd: And your objective is to fund that traditional regional bank with retail deposits. Is that right?
Foster: Yeah. One of the key planks for taking the business forward is that we're going to move and have a retail to loan ratio in the vicinity of 60 per cent to 70 per cent. Historically part of our legacy has been a lower deposit ratio than many competitors, partly influenced by some of those non-core portfolios which traditionally haven't attracted a high level of retail deposits, so that puts us in a good position. In the core portfolio we're starting now from a position of around the 60 per cent mark which certainly puts us in a competitive space and certainly since September last year we've continued to grow our deposit base very, very strongly.
Boyd: So could you just explain why the non-core bank is effectively going into run-off and that you hope to have about $10 billion of the $16.8 billion going off the books by the end of 2011?
Foster: In terms of our non-core book, back in November we obviously looked at those areas that we could sustain competitive advantage and looked at the funding mix and costs on a go forward position. I guess one addition to that in recent weeks that we've worked through is clearly the funding markets are still going to provide a significant increased cost to where they were prior to the credit crunch.
But, importantly, we've developed our risk profile for the core business going forward and as a result of that we've moved the remainder of our property finance book into the non-core part of the book. That non-core essentially totals a bit under $17 billion and if you look at contractual run-off terms, that would reduce to around $6 billion by the end of FY '11. Clearly that's subject to a number of variables including the refinancing market for customers and the pace of property sales and the like, so I do stress it's a contractual profile. But to manage that business we have set up a dedicated and specific business unit to manage that made up of very experienced bankers.
Their focus is quite intense individual account management of all the customers within that portfolio and their objective is clearly to manage the run-down and the credit quality of that portfolio as effectively and efficiently as possible. We'll also be looking at opportunities whether it be on an individual credit basis or on a sub-portfolio basis to see if we can move parts of that portfolio off our books quicker than the contractual or actual profile of that book.
Boyd: So you are willing to sell chunks of the non-core bank, but banking will remain core to Suncorp's strategic direction, will it?
Foster: Certainly the bank's a core part of the group and strategically important. It is very important to note that the strategy that we've developed is the strategy for the business under whatever scenario that you could play out whether it be continuing the core part of the business and competing on that basis into the future. We do believe strongly in the ability of that core business to compete effectively in the long term, likewise the run-down activities in the non-core part of the group would be required whether or not you have a scenario that retains the bank within the group or, as some speculation talks about, selling the bank, but the strategy itself would be consistent under whatever scenario.
Boyd: To what extent has the government guarantee of wholesale funding been the catalyst for you to take this action with your creation of a non-core bank?
Foster: I think the government guarantee was an absolutely necessary step at back end of last year to provide stability to the banking system overall. It certainly has our support as it does from the whole industry. It's not the guarantee so much that's determined our strategy in terms of the core or non-core, but I guess our long term view that the narrow differences between A and AA institutions won't be returned to the levels that we saw a couple of years ago prior to the credit crunch.
What I would say in addition to the fact that the guarantee was necessary to stabilise the system, I think what we have seen, which is perhaps unexpected when the guarantee was put in place, is that in addition to the pricing differential to the guarantee fee itself where we as an A organisation pay a guarantee fee of 100 basis points versus a AA organisation at 70 points. The market itself is also building in a differential of 20 to 30 points in terms of funding and to that end that's probably an unexpected consequence of the structuring of the guarantee and that differential of the 20 to 30 points which is certainly a lot broader than the difference that existed prior to the credit crunch. That has certainly featured in our considerations of what was core and non-core and where we would compete. A lot of the portfolios that we've moved into non-core have tended to be those more finely priced margin products that are under a wider differential of funding we won't be able to compete in.
Boyd: Could you just give us some comment about what's happening with Suncorp's bad debts?
Foster: Well, certainly we're not providing a comprehensive update or any update on bad debts as part of this briefing. We'll be providing an update, as we normally do, at our Basel II Pillar 3 disclosures later in the month on the 26th of May. But what I would say is that, consistent with the industry, we continue to see some deterioration in the credits across the board. But they're broadly in line with our expectations that we articulated in February in terms of our outlook for bad debts and pleasingly the processes that we put in place over the last few months have certainly provided some comfort. No surprises have emerged from the book and likewise we haven't incurred any single name exposures or the big exposures that have been announced through the industry in recent weeks.
Boyd: And your impaired loans, are they being kept in a sort of separate parcel away from the core or the non-core banks?
Foster: Well, as with most institutions we've certainly got our core business and the non-core business. As I said it's not determined by credit quality. As with most banks we've got a separate asset management unit, which forms part of our credit organisation within the bank and for those requiring work-out positions, they're actively managed again by very experienced experts in work-outs within our asset management unit.
Boyd: What has the cost of funding done to the profitability of the non-core bank?
Foster: Well, I think there are a couple of dimensions at play there. At a headline level, under historic margins, you could find that equipment finance and property would tend to have higher than our average margin whereas corporate banking and property investment would tend to have lower than our average margins. Now, that's under the, I guess, old world scenario. Clearly given our strategy to eliminate any funding risk of the non-core book, that's required and driven the need to increase the level of term debt that we've attributed to and used to fund that non-core book and obviously that's at a significant cost compared with what funding used to be at. That coupled with lower margins we fully expect that the average margins of the non-core book will be significantly lower than the margins of the core book which are predominantly funded through retail deposits and a combination of other funding sources.
Boyd: Now, finally the board's looking for a new chief executive. Have you thrown your hat in the ring?
Foster: No. I'm pretty busy and focused on the job at hand with the bank. Certainly the the chairman's advised that a process is underway and I'm sure he'll update the market as appropriate.
Business Spectator