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Standard Chartered - Q3 losses, strategic review and rights issue

Steve Clayton | 3 November 2015 | A A A
Standard Chartered - Q3 losses, strategic review and rights issue

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Standard Chartered plc Ordinary US$0.50

Sell: 461.70 | Buy: 461.90 | Change -9.60 (-2.04%)
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Third quarter results from Standard Chartered (STAN) are clearly disappointing; the bank has reported a loss of $139m as a result of an impairment charge that more than wiped out the operating profits achieved in the quarter. The group has also announced a strategic review, accompanied by a $5.1bn 2 for 7 rights issue at 465p, a discount of 35% to the previous closing price and a 29% discount to the Theoretical Ex-Rights Price (TERP). The final dividend is scrapped.

Third quarter income fell 18% year on year, reflecting weak client activity and the bank's efforts to reduce riskier exposures. Operating expenses fell 3% year on year, despite a 44% increase in regulatory expenses, so far this year. A "critical assessment" of the loan book led Standard Chartered to book a $1.2bn loan impairment charge, reflecting trends in India and Commodities in particular. This, plus a separate $161m impairment of other assets outweighed operating profits of $1.183bn, leading to the reported loss.

The shares have opened 5% weaker.

Strategic Review:

A new business strategy, combining tighter risk tolerances with a greater focus on affluent retail clients and lower levels of investment banking with its higher asset intensity and volatility of returns.

Restructuring of divisions accounting for one third of group risk weighted assets (RWAs), including $50bn of RWAs in the investment bank, where returns must be raised or the activities exited, $30bn of RWAs in countries where the group is clearly unhappy with its current position, $20bn of RWAs now considered too risky and $5bn of peripheral businesses that STAN now wishes to exit.

Cost reduction targets substantially increased to $2.9bn over 2015-2018, with total costs in the final year to be lower than in 2015, notwithstanding inflationary impacts.

$1bn to be invested into the Retail Clients systems and digital capabilities. Private Banking and Wealth Management are to be repositioned and Africa banking and renminbi-based services upgraded.

The regulator has raised no objections to the plans. Pending Bank of England stress test results are not yet known. The BoE will publish them on Dec 1.

The strategy is designed to refocus the group on more profitable and less capital intensive businesses. STAN is targeting an increased Common Equity Tier 1 ratio of 12-13% and, in the medium term, a return on equity of 10%.

Rights Issue:

A rights issue has been announced with 2 new shares for every 7 existing shares at an exercise price of 465p to raise $5.1bn (approx £3.3bn) - Temasek, STAN's largest shareholder will take up its rights. Temasek holds 15.8% and is acting as a sub-underwriter to the issue. The rights issue is fully underwritten by J.P. Morgan Cazenove and Bank of America Merrill Lynch. Timetable as follows:

No final dividend will be paid for FY 2015
The record date for entitlements to the Rights Issue is 5.00pm on November 13
Provisional Allotment Letters will be dispatched November 18
Nil Paid dealings, and existing shares to be market "ex-rights" at 8.00am November 23
Latest time and date for acceptance and payment in full will be 11.00am December 10

Our view:

Standard Chartered are holding a gun to their investors' heads with this rights issue. The discount is large and the theoretical ex-rights price far below the pre-announcement closing price. Holders who do not take up their rights face big dilution. Some though may well look at the run-rate of impairment charges currently racking up and decide that the rights issue will be good money after bad.

Standard Chartered is now a bank with strong emerging market exposures, at a time when the emerging markets are not strong. The stock was trading far below tangible book value (TNBV) of $15.86 but given returns were only 5% or so, that was hardly surprising.

That tangible NAV will be diluted by the issue; we estimate a post-rights TNBV of around $13.93, or just over 900p. So the rights is being struck at around half of the new book value and the current market price is a substantial discount to TNBV also.

The question is, can those $2.9bn per annum of cost savings make it through to the bottom line, or will they be competed away, or swallowed up by bad debt charges? The latter are coming in thick and fast, but perhaps Mr Winters has insisted on a kitchen sink approach to provisioning.

The new strategy is a big back-pedalling from the previous direction. Gone is the approach of getting in close, with an open chequebook, to the key industrial families of South East Asia in an attempt to become their primary commercial and investment banking partner. Instead, Standard Chartered is focusing more on establishing strong private banking relationships with the wealthier citizens of the emerging markets.

Done well, private banking is a great business. Ask the Swiss. It offers potentially steady returns with limited risk, because lending tends to be well secured, because the clients are rich. Whether Mr Winters can pull it off remains to be seen, but he has the network and the brand necessary to make a go of it.

In the long run, Standard Chartered's emerging market bias could be a huge positive. Right now though, China and India are more of a worry than a blessing and investors will need patience to see them through what could be quite a lengthy turnaround process. If the bank can hit the 10% Return on Equity target, and pay out half of earnings as dividend, then an attractive dividend yield may one day be possible, given the shares are trading far below book value. Getting there will be easier said than done, however.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.