Suncorp Group: Is T2 Paying Enough Given the Downside Risk?
Various articles have surfaced that Suncorp Group might be spinning-off (for a demerger) or selling the bank. This is not new news and interestingly surfaced at a time when Volt Bank has decided to exit the banking industry after 3.5 years. Volt had obtained an unrestricted ADI license from APRA in 2019. It intends to return all funds to depositors and give up its banking license.
In a volatile market as funding costs rise and sources of capital dry up because of investor angst, it will be testing time for other companies as well that began operations in recent years. For subordinated T2 and AT1 investors at the Suncorp Group, it’s worthwhile considering the implications and examining whether their current exposure to Suncorp Group is appropriate. Note, there is no change of control for T2 and AT1 investors, so one is left unprotected in this situation.
Our advice: There is a risk Suncorp Group T2 spreads reprice wider once new information comes to light. The market is currently discounting news of any negative credit implications and rating downgrades that could eventuate. Because there is no change of control protection in these notes and there’s real event risk, the question investors need to ask is: “Am I getting paid sufficiently for this risk?”
Presently, we would argue no.
There are other T2 subordinated securities out there which offer a similar (or better discount margin) of 240-250bps for a 3-5 year first call and have less risk. Thus, we would be switching our capital into these better risk/return opportunities where available.
Two great opportunities to switch are from recent deals, including the MQGAU Float 06/07/32 and CBAAU Float 04/14/32. Both offer a similar (or better discount margin), are safer credits, and can be easily accessed in the market.
Another option is the BQDAU Float 05/19/32. Again, it offers a similar discount margin, a safer credit (especially after the ME Bank transaction), and can be easily accessed in the market.
Chart 1. Bloomberg Pricing
For context, Suncorp Group operates as a holding company and is regulated by APRA. The bank and insurance operating businesses are wholly owned subsidiaries.
If a spin-off or sale occurs, there will be negative credit implications for T2 and AT1 investors and Suncorp Group would lose the earnings diversity that the banking business provides. The bank provides almost 55% of the group’s cash NPAT and a partial uncorrelated return to the insurance business.
The other issue is that T2 and AT1 regulated capital is issued from the group and then funnelled down to the bank and insurance businesses. A spin-off or sale would require APRA to be comfortable with the regulatory capital positions of the two entities.
What Have Rating Agencies and the Market Done Since the News Surfaced?
- Suncorp Group A2 / A+ / A+ (Moody’s/S&P/Fitch)
- Suncorp Bank A1 / AA- / A+ (Moody’s/S&P/Fitch)
The bank’s standalone rating is lower at baa1 (Moody’s) and bbb+ (S&P) due to the implied support from the group.
T2 issued by Suncorp Group: BBB+/A- (S&P/Fitch; no Moody’s)
S&P have already lowered the bank’s rating to A+ (from AA-). No action was taken on the group yet, although there could be multiple rating downgrades in the near term.
Changes in Discount Margin of Selected Suncorp T2 Securities Since the News Surfaced
Chart 2 below shows Suncorp Group’s spread movement over the recent period. Since the news surfaced, there’s only been a small change over the last week – but again, this is not new information, and it will take time for this to potentially play out.
At present, the market is currently discounting the news of the negative credit implications that could eventuate under a spin-off or sale process. But there is still a risk of Suncorp Group T2 spreads repricing wider once new information comes to light.
Chart 2. Suncorp Spread Movement