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Standard Chartered - income struggling and bad loans up

Nicholas Hyett, Equity Analyst | 29 October 2020 | A A A
Standard Chartered - income struggling and bad loans up

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Standard Chartered plc Ordinary US$0.50

Sell: 606.20 | Buy: 606.60 | Change 6.80 (1.13%)
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Standard Chartered reported operating income in the third quarter of $3.5bn, down 11% year-on-year once the effect of currency movements are stripped out. Quarterly profit before tax fell 62% to $435m, as provisions for bad loans ticked up and the bank wrote down the value of its business in the UAE.

The bank has said it will "consider... resuming shareholder returns" at full year results.

Standard Chartered shares fell 4.9% in early trading.

View the latest Standard Chartered share price and how to deal

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 lower interest rates are squeezing margins in the loan book. 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 14.4% 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. Whether that's the right call or not is up to individual investors.

Standard Chartered key facts

  • Price/Book ratio: 0.21
  • 10 year average Price/Book ratio: 0.85
  • Prospective dividend yield (next 12 months): 4.11%

All ratios are sourced from Refinitiv. 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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Third Quarter Results - at constant exchange rates

Net interest income in the third quarter fell 16% to $1.6bn. That reflects a decline in net interest income (NIM - the difference between what the bank charges on loans and pays on deposits) from 1.61% a year ago to 1.23% this quarter, more than offsetting a modest increase in loans and advances to customers. The lower NIM reflects the move by central banks around the world to cut interest rates.

Other income fell 7% to $1.9bn, as a strong performance in the Wealth Management and Financial Markets businesses were offset by losses in Treasury resulting from hedging ineffectiveness.

Operating expense were flat year-on-year at $2.5b, however the decline in income meant the overall cost:income ratio increased substantially from 62.9% to 70.5%. Credit impairments (provisions for bad loans) rose 32% year-on-year to $353m, although they were well below the second and first quarters.

The bank's CET1 ratio (a key measure of banking capitalisation) of 14.4% was up on last quarter (14.3%) and the start of the year (13.8%). That's above the banks medium term target of 13-14%, despite declining credit quality hitting the overall ratio.

Return on tangible equity, an important measure of profitability, fell from 8.9% a year ago to 4.4%.

Standard Chartered expects conditions to improve over the course of 2021, with net interest margins to stabilise slightly below the current level over the next two quarters. As a result the bank will focus on its fee based Wealth and Financial Markets businesses, while reducing operating expenses where possible.

Find out more about Standard Chartered shares including how to invest

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 Refinitiv. 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.

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.

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