Two years ago, Standard Chartered plc made headlines
when it was fined $667 million by the US federal and New York state authorities
for laundering, including through its New York unit, some $250 billion on behalf
of Iran, Sudan, Libya and other countries in violation of American sanctions.
Going a long way to explain how the bank got into its
regulatory travails was the memorable line attributed to its then Chief
Financial Officer: “who these f***
Americans think they are to tell us what to do”. Not only did the bank hide its illegal dealings,
it obfuscated (before being forced to cooperate) and even threatened to
countersue the NY Department of Financial Services for causing damage to its
reputation!
Back in August of 2012, I wrote that Standard’s
difficulties stemmed from either a culture harking back to the Indian colonial
days or the need to preserve a business overly dependent on risky emerging
markets (EMs). Either way, although its
stock price had then fallen in the mid 1300s[1],
I felt that the conditions were not met to justify investing in the stock.
Today the stock is at 1,218p, yet I don’t feel
tempted to buy. First semester 2014 net income is expected to be down 20% year-on-year[2],
full year 2013 net income was down 15% from the year before, and 2012 net
income was essentially flat with 2011; return on common equity has been
trending down steadily since 2004[3];
loan impairments have been rising (+35% in 2013)[4]. Finally, the business risk profile of the
bank remains, in my opinion, high, with close to ¾ of its loan book in emerging
markets as well as almost all of its profits[5].
Culturally, and despite some senior management
reshuffling since the 2012 fiasco, not much has changed according to a Financial Times article of 7/24/14 which
noted “widespread criticism that the bank
is run like a colonial empire” and that “arrogance
at the bank has got so high”.
Criticism from large shareholders has mounted, so
much so that the bank’s board felt obliged yesterday to issue a press release
reiterating its support for the current CEO; and last May, 41% of voting
shareholders rejected the new management pay policy. It may well be that the bank owners will
force a change in management; but that does not guarantee a change in
culture. Culture in an institution that
spans vast regions and whose Country Heads are generally all powerful (because they
possesses far more local knowledge than Head Office does), is hard to reshape.
More crucially, I believe that Standard Chartered is
following a high risk strategy by being so dependent on emerging markets,
particularly Asia. I have some
experience in this, having spent my banking career with a bank (American Express
Bank Ltd) which had a similar emerging markets focus, although with greater
regional diversification[6].
China and Hong Kong are the single largest business
focus of Standard Chartered. While I am
sure that its country officers have good knowledge of their local customers and
counterparts, I don’t think that they have a comparable knowledge of the
macroeconomics or politics, because nobody really does. That is a big risk that
the bank is assuming.
While emerging markets have had faster economic
growth than the developed ones over the span of several decades, they also have
had more crises and these have been more severe[7]. These crises have also tended to spread from
one emerging market to another as individuals and institutions rush out to cut
risk.
Because of their inherent leverage, banks are most
exposed to financial and economic crises.
When such crises hit emerging markets, the big international money
center banks can usually count on their large home businesses to absorb EMs
losses; this was evidenced by the Latin American crisis of the 1980s, the
Mexican crisis of 1994 and the Asian crisis of 1997-1998. But a bank such as Standard Chartered has no
large home market to fall back on, and should such an EM crisis come about, it
will find that EM central banks have neither the resources nor the inclination
to save foreign banking institutions operating on their soil.
So while Standard Chartered looks cheap, it remains,
in my view, beset by two big problems: (1) “tainted” management team and culture,
and (2) overexposure to emerging markets.
The first problem may soon see the beginning of a solution, but changing
a culture takes time. The business
strategy is much more complicated (and costly) to fix, and some of the biggest macro
risk factors affecting the bank are very difficult to assess.
JP Morgan has better management, a lower risk
profile and better profitability, and it sells for 1.06x book value and 1.45x
tangible book value. Standard Chartered
sells for 1.11x and 1.31x[8]
respectively. Is that logical? I don’t think so. In my opinion, STAN should probably sell at a
25% valuation discount to JPM. This would
put STAN stock price at 878p to 912p.
I remain on the sidelines, neither owning not
shorting the stock.
[1] After recovering from a precipitous drop to
1,228p on 8/7/12.
[2] As per management preannouncement.
[3] Source: Bloomberg.
[4] Source: JP Morgan.
[5] It is estimated that close to 70% of the
profits come from Asia and the subcontinent and another 25% from Africa and the
Middle East.
[6] Coincidentally, American Express Bank Ltd
was sold to Standard Chartered in 2007.
[7] Obviously, the US and Europe have just had a
very severe crisis, but I would argue that it has forced them to take remedial
measures.
[8] Based on end of year 2013 tangible and
overall book value.
