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Standard Chartered - bad loan provisions knock profits

Nicholas Hyett, Equity Analyst | 30 July 2020 | A A A
Standard Chartered - bad loan provisions knock profits

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Standard Chartered plc Ordinary US$0.50

Sell: 464.90 | Buy: 465.00 | Change -6.60 (-1.40%)
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Standard Chartered reported a 5% increase in operating income in the first half, reaching $8.0bn, with costs falling too. However, that was more than offset by significant impairments related to bad loans, with profit before tax down 25% to at $2.0bn.

The bank expects income to fall in the second half, but while impairments will continue these should be lower than those recorded this half, if economic conditions don't deteriorate.

The shares were broadly flat in early trading.

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Our view

Standard Chartered may be UK listed, but it's really an Asian bank. That didn't exempt it from the Bank of England's call for the sector to scrap any dividends until next year, but it does make its position in the current crisis rather different.

Volatility in financial markets has translated into a bumper result in the investment bank while corporate lending has spiked as companies look to secure access to extra cash. The bank's made significant provisions for higher loan defaults resulting from the crisis.

So far, so familiar.

However, there are some signs the group's Asian markets have weathered the current coronavirus storm better than their Western counterparts. While we remain wary of the risk of a second wave of virus infections, and additional lockdowns that would bring, that could mean Standard Chartered turns the corner quicker than more domestically focused rivals.

The bank is also more exposed to dollar interest rates than sterling. And while the recent Fed interest rate cuts have knocked hundreds of millions off revenues, historically the US central bank has been better able to raise rates again than the Bank of England.

Low interest rates are a problem because while falling rates will largely be passed onto borrowers (thanks to a combination of base rate tracking loans, competition and regulatory action) the interest banks pay to savers is already on the floor. With little room to push funding costs lower the net interest margin (the difference between what the bank can make on loans and pays for funding) will be squeezed. If dollar interest rates were to rise that might help boost the profitability of loans.

It's worth noting though that Standard Chartered does face headwinds from weakening emerging market currencies and a strengthening dollar. Companies that borrow in dollars but earn profits in local currencies will find borrowing more expensive, and Standard Chartered's local currency denominated profits will be worth less.

The good news is that Standard Chartered is relatively well capitalised, despite the recent loan impairments, and the current 14.3% CET1 ratio is above the 13-14% target range. We note that in half year results the bank said it would look to return surplus capital to shareholders when conditions became clearer. That probably bodes well for a full year dividend - although with growth to fund, the size of any shareholder return is less clear.

Early on in my career I was told that 'if you want exposure to a particular economy, buy a bank'. That remains true today. Standard Chartered is arguably a straightforward play on a stronger recovery in Asian markets than in the West.

Standard Chartered key facts

  • Price/Book ratio: 0.2
  • 10 year average Price/Book ratio: 0.9
  • Prospective yield: 3.6%

We've introduced this section in response to recent survey feedback.

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results (Constant Exchange Rates)

Net interest income fell 7% in the first half to $3.5bn, offset by a 20% increase in other income to $4.5bn.

The lower interest income is despite an increase in overall loans to customers, and reflects the impact of lower interest rates on the bank's net interest margin (the difference between what the bank charge borrowers and pays depositors). Net interest margins fell 0.26 percentage points to1.40% for the half, and 1.28% for the second quarter.

The substantial growth in other income reflects a strong result in Standard Chartered's Financial Markets business, where income rose 35% to £2.2bn thanks to a strong result in fixed income, currency and commodity trading activities.

Impairments for bad loans during the half reached $1.6bn, compared to $254m in the same period last year. However, impairments in the second quarter were lower than those seen in first 3 months of the year. The increase reflects the deteriorating macro-economic environment and a small number of specific large clients in the Corporate and Institutional Bank.

The bank's cost:income ratio improved substantially year-on-year, from 59.5% in 2019 to 49.8%. That reflects a 5% fall in operating expenses, or 2% on a constant currency basis, as well as higher revenues.

Standard Chartered's CET1 ratio has risen to 14.3%, above the top end of the bank's target range of 13-14%. Once the economic environment has become more settled the group will return any surplus capital to shareholders once growth opportunities have been exhausted.

The bank believes some of its larger markets "will start to drive the global economy out of recession over the coming quarters". However, income is expected to be lower next half, with expenses set to rise (although the aim is for full year costs to come in below $10bn in both 2020 and 2021).

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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