No-moat-rated Standard Chartered (STAN) conceded on November 3 that it needed to raise capital, much as we had said it would. The amount to be raised, £ 3.3 billion, and the price £4.65 per share for the equity rights, were in line with our expectations. Management said that the fresh capital would increase the bank’s June common equity Tier 1 ratio to 13.1% from 11.5% as reported, in line with our view that 13% is the new baseline for global banks. In our baseline scenario, we think this capital raise is sufficient, although we cannot rule out the need for additional capital if credit losses are significantly worse than we are forecasting. The results of the U.K. stress test, which will incorporate emerging-market risks for the first time, will not be available until early December.
The scale of the operational change that is needed is shocking
While the capital raise is essentially as expected, news about the strength of the bank’s business was worse than anticipated, even in lieu of the fact that we removed the bank’s narrow moat rating earlier this year. We plan to reduce our £10 per share fair value estimate by 10%-15% as we incorporate a lowered forecast for future earnings into our valuation. We were especially disappointed by management’s return on equity target of 8% for 2018 and 10% for 2020 – both figures are well below the 12% cost of equity we assign to the bank, and below the nearly 10% rate we'd expected the bank to earn in 2018.
The size of the restructuring that CEO Bill Winters is planning indicates that the bank’s woes are deeper than we'd known. While we had expected credit problems, given Standard Chartered's Asian-focused footprint and trade-focused business model, the scale of the operational change that is needed is shocking. Management said that 90% of the new client process is currently paper-based, and that turnaround times are five days. They are targeting 10% and less than one hour respectively.
Winters is planning to invest $3 billion over the next three years, equal to 60% of peak profits in 2012 and 115% of 2014 profits. The scale of change that Winters is planning is dramatic – he plans to restructure one-third of risk-weighted assets, including exiting peripheral businesses, and liquidating assets beyond the bank’s risk tolerance.
While the details are scarce, we think that execution risks will be significant. Moreover, the markets in which Standard Chartered operates, while growing faster than developed markets, are increasingly competitive. We see little reason for investors to bank on Winters outperforming his modest profitability goals.
