We are reducing our moat rating for Standard Chartered (STAN) to none from narrow. While we continue to think that its network across emerging markets is attractive to its international trade oriented clients, we think that increasing regional competition, rising regulatory costs, and slowing economic growth in its markets will make it difficult for Standard Chartered to significantly out earn its cost of equity.
Standard Chartered's regulatory costs, including the amount of capital it must hold, have increased significantly, which has made it more difficult for the bank to earn excess returns. Like all global banks, it faces higher operational compliance costs than it did before the crisis, and uniquely as it complies with its settlements of money laundering charges.
Capital costs have increased also: Standard Chartered's equity/assets ratio has increased from 5.1% in 2008 to 6.4% at the end of 2014, and we expect it to increase to just over 7% as the bank gives in to shareholder and regulatory demands that it hold more capital.
This will make it mathematically more difficult for the bank to earn attractive returns, holding return on assets constant. Standard Chartered is designated as a bucket 1 global systemically important bank, or G-SIB, which means it is subject to greater regulatory scrutiny than non-G-SIBs and must hold additional risk-absorbing capital worth 1% of risk-weighted assets.
This puts it at somewhat of an advantage relative to its biggest competitors, HSBC and Citigroup, which must hold additional capital of 2.5% and 2.0%, respectively, but at a disadvantage to regional competitors not designated as G-SIBs. Standard Chartered may also be at a competitive disadvantage relative to Chinese competitors that will not be required to meet the not yet finalized total loss absorbing capital requirements.
Standard Chartered’s U.K. domicile may further put it at a cost disadvantage relative to competitors, as it is subject to the U.K. bank levy. In 2014, it paid a levy of $366 million, equal to 8% of operating profit.
While the recent dip in Standard Chartered’s profits is largely cyclical, we think that its historical returns may not be as strong of evidence of a moat as they may appear. The bank's loan losses have risen sharply as China's growth has slowed and commodity prices have tumbled, and evidence is growing that Standard Chartered may have garnered high returns by taking on more risk than competitors. For example, commercial real estate and mining and quarrying increased to 10% and 8% of wholesale loans in 2014, respectively, from 7% and 7% in 2010.
