Standard Chartered PLC: Toxic But Tempting

Standard Chartered (LSE: STAN) (NASDAQOTH: SCBFF.US) emerged from the financial crisis with a relatively clean bill of health. It didn’t last. We now know it is sitting on a growing stockpile of toxic loans, and the stink is growing.

A recent report in The Times warned the bank has a swelling category of loans to wealthy Asian clients that have been reclassified as high risk, raising the prospect of further loss provisions.

Could investors be in line for a toxic shock?

Credit Impaired

The truth is they’ve already had one. Standard Chartered’s loan impairments spiralled to $1.61 billion last year, up from $1.2 billion in 2012. That largely explains why the share price is down 25% in the past 12 months. 

The share price could fall even further if the toxic stench mounts. But I still find the new, lower price tempting.

Foreign Affairs

Whether you’re tempted partly depend on how you see the outlook for emerging markets, where Standard Chartered generates a mighty 90% of its earnings.

It also depends on whether you reckon the Chinese authorities can successfully deflate their credit and property bubbles.

There are some positive signs. Chinese exports leapt 14.5% in the year to July. Manufacturing rose at the fastest pace in two years. Premier Li Keqiang has targeted GDP growth of 7.5% this year. That still looks doable.

Especially if the US recovery continues, sucking in imports.

Standard Slips

Standard Chartered’s recent half-year results were preceded by a profit warning, but its 20% drop in profits before tax was still shocking. Especially after a decade of unbroken earnings growth.

Its investment arm is struggling, while its South Korea business is in a mess.

Yet the balance sheet remains sturdy, with a core tier 1 ratio of 11.8%.

And if the economic cycle swings back in favour of emerging markets, now could prove a good entry point.

Peace On Earth

If you’re tempted, you may have to be patient. HSBC isn’t the only bank to complain about the growing regulatory burden, Standard Chartered chairman Sir John Peace has just bemoaned “the intensity of regulatory pressure and political risk”. I expect this to continue, as the authorities take slow but sweet revenge for the credit crunch. 

The US has just fined the bank $667 million two years ago for breaking sanctions on Iran, and now appears to be readying itself to impose further (although probably lesser) penalties. 

Anybody investing in the banks has already learned to take this kind of punishment in their stride.

Income Fun

It will take years before management can drain all the toxins. Despite that, there are strong arguments for buying now.

Following that sharp share price fall, Standard Chartered now trades at 12.1 times earnings. That’s a decent valuation, for a bank that has typically traded at a premium valuation to its sector. It also yields 4.21%, and management has a progressive dividend policy.

And despite that 20% drop in profits, it still generated $3.3 billion in the last six months.

Last week, Investec claimed that Standard Chartered is “still probably the best bank in the world”, and predicted that revenues should grow in the second half of the year and beyond. I wouldn’t stick my neck out that far, but if you can take a five-year time horizon, the bank looks more tempting than toxic.