Argonaut Capital: Why we have increased our short position in Standard Chartered

Jonathan Boyd
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We also think that asset quality in its underlying markets is deteriorating much more rapidly than the company’s recognition of non-performing loans would suggest. Yesterday’s H1 statement revealed that STAN’s corporate NPL ratio had risen to 4.5% (from 3.8% at the end of 2014) but this is still relatively low by historic emerging market standards in a cyclical downturn. Our experience of the downturn in asset quality in Europe was that banks were much more willing to restructure loans and that this often masked a deeper downturn in credit quality (or at least delays or in some cases is still delaying its recognition). We suppose the same is true in Asia and EM. Hence since 2011 STAN has seen significant growth in the “restructured loan” category, which are now equivalent to the stock of non-performing loans and which are excluding from analysis of coverage ratios. This indicates that asset quality is already more problematic than headline numbers would suggest.

STAN’s new CEO has been candid admitting “we grew aggressively in certain markets, we accepted high concentrations by industry, by geography and by individual borrower, and we have found some weak operational controls which exposed the group to losses and fraud”, which does not fill us with huge amounts of confidence that all the skeletons have yet fallen from the closet. Indeed, we think that the credit cycle will get much worse for STAN. Management currently identifies its problem areas as “commodities, China and India” but it is frankly difficult to identify any area of the STAN balance sheet that is now particularly safe, or at least early cycle. Around a quarter of its corporate loan book is exposed to Hong Kong which operates a US dollar peg, whereby bank lending is effectively priced off the US yield curve in order to maintain a fixed exchange rate, irrespective of whether it is appropriate for the Hong Kong economy. The credit cycle in Singapore, STAN’s other main Asian exposure, which operates a wider targeted currency peg, is similarly correlated, albeit to a lesser degree. Both Hong Kong and Singapore have undergone multi-year expansion in credit which accelerated as a result of Fed Chairman Bernanke’s QE. So when the Federal Reserve begins its hiking cycle, asset quality can only deteriorate further for STAN and the bank will likely face a synchronised credit downturn across all of its markets, even in those which have hitherto proven resilient, particularly now the Chinese fixed asset investment boom would also appear be over. This makes market forecasts that P&L provision charges will peak at 82bps cost of risk in FY 2015 somewhat ludicrous (particularly as the annualised cost of risk was 114bps in H1).