In a way, Standard Chartered (STAN) sums up the problem with bank stocks. I say that because on paper it looks like a very good long-term proposition. The bank is largely an Asian and emerging market player for one, while it also generates the lion’s share of its income from corporate and institutional banking. Those points should make it a fairly straightforward way to get exposure to above average GDP growth and increasing trade. And for a long time, this did look like an attractive dynamic: loans to customers increased from around $110b to $290b between 2005 and 2014, while pre-provision profit before tax followed a similarly impressive trajectory, increasing from $3b to $7.5b.
So far, so good. But to come back to the first sentence – banks also come with a host of potential pitfalls. They are cyclical for one, and that means management teams need to be constantly on the ball from a risk perspective. In Standard Chartered’s case, things unravelled somewhat during the commodity price and emerging market downturn in 2015. Its exposure to the commodities sector was fairly high, serving it well in a boom but not so good in a downturn. Bad loans rose, while provisioning in the good years had been inadequate. Management announced a restructuring of the business and tapped shareholders for circa $5b to fund it. Naturally this rights issue also took place at a steep discount to the then share price. Oh, and the dividend was also scrapped in order to increase retained earnings and further bolster the balance sheet.
The above obviously knocked the wind out of the bank’s sails. Bad assets were offloaded, with exposure to riskier areas like commodities reduced. That contributed to a permanent hit to the top line versus pre-2015 levels, but operating expenses did not fall away in tandem. Loan loss provision also remained elevated for a while, though this subsided. Anyway, the overall net impact meant tumbling income, with the bank’s profitability metrics following suit. Pre-COVID return on tangible equity came in at around 6-7%, way down on the double-digits earned prior to 2015.
COVID The Latest Setback
That brings us to the present, with COVID now the latest setback. The direct hit from the pandemic was actually not too bad, certainly compared to what could have been. Still, the bank booked a $2.3b credit impairment charge, up from just over $900m in 2019. Actual net charge-offs clocked in at around $1.7b, with non-performing loans increasing by around $1.8b to $9.2b.
The other more indirect issue is the headwind from lower interest rates. Standard Chartered might not depend on interest income to the extent that some other names do, but it stills feels a big pinch from lower rates. The bank’s net interest margin tumbled to 1.31% last year from 1.62% in 2019. A $13b increase in the loan book, largely driven by Korean and Hong Kong mortgages, helped offset that somewhat. That led to net interest income of $6.9b, an 11% fall year-over-year, although that includes a two point headwind from the stronger US dollar. That was partially offset by higher non-interest income, which has generally been a boon for the banks during the downturn. Increased market volatility and trading activity helped boost that 4% to $7.9b, while a welcome reduction in operating expenses also helped take some of the sting out of lower interest income.
Offsetting factors notwithstanding, the above still led to a relatively chunky fall in overall profit. Pre-provision profit before tax fell around 4% to $4.6b last year. Elevated provision charges then saw the bottom line fall even further. Underlying pre-tax profit slumped 40% to $2.5b, while the bank’s return on tangible equity (“RoTE”) came in at just 3%.
Targets Pushed Back
That last figure is obviously a million miles away from where the bank wants to be. Management had previously targeted a return to earning a double-digit RoTE by 2021. While obviously outside of its control, the impact of the past 12-15 months, particularly from lower interest rates, does mean that its previous goal is clearly obsolete now. Updated guidance sees a 7% RoTE by 2023, with the previous 10%-plus target now extended out to the medium-term.
On the plus side, capital returns to shareholders received the green light again. Being London based meant that Standard Chartered got caught up in the Bank of England’s freeze despite the lion’s share of the bank’s activity taking place in Asia. That, plus a better than expected 2020, also meant that retained earnings were largely left to accumulate. The bank’s CET1 ratio increased to 14.4% at the end of 2020, ahead of its 13-14% target. Anyway, the bank declared a final dividend of $0.09 per share – worth around $285m in aggregate terms. Management also announced a resumption of the stock buyback programme, with that worth another $250m or so. The implied shareholder yield is relatively puny – only around 2.5% – but that was the maximum capital return allowed based on the regulator’s formula.
Valuation Somewhat Attractive
This year looks set to be another tough one on the revenue front. Sequential figures in the last quarter of 2020 looked poor, and management reckoned that 2021 would be flat at best in terms of the top line. Same story with the expenses line, though lower provision costs should at least help on the profit front. The bank reports first quarter 2021 results in a couple of weeks.
After that, well, the 2023 target of earning a 7% RoTE is not exactly aggressive. Management sees 5-7% income growth, with pre-provision expense growth running below that, as helping it get there. That looks fairly reasonable given the areas the bank operates in, and is basically in line with GDP growth projections. There is also scope for efficiency gains such as from investing in technology and so on.
Standard Chartered shares trade at just over the 490p mark at time of writing. Tangible book value stood at around 900p at the end of 2020, so quick maths puts the stock at circa 0.55x TBV. The current share price also works out to a price-earnings ratio of circa 19 based on depressed 2020 earnings. I know the bank has been a disappointing investment in recent times, and yeah, it’s far from the highest quality name out there, but that still strikes me as quite cheap. A 6-7% RoTE would support a fair value closer to 650-700p in my view. Still, given the difficult past few years, not to mention the relative abundance of seemingly cheap bank stocks out there, it wouldn’t be a surprise if investors looked the other way.
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