Standard Chartered’s ($STAN) Salad Oil Moment

Up until the start of this month Standard Chartered ($STAN) was considered a traditional, boring bank.  Some went as far as calling it the ultimate retirement stock.  It is a commercial bank that helps its clients (almost all in Asia, Middle East, and Africa) conduct their business – providing clearing, letters of credit and funding.

The Scandal

At the start of the week, it became publicly known that the bank may have been too helpful.

New York State’s Department of Financial Services this week said the London-based lender conducted $250 billion of deals with Iranian banks over seven years and processed transactions for institutions subject to U.S. economic sanctions, and may lose its state license. The shares have slumped 22 percent in London since the Aug. 6 order, erasing 8 billion pounds ($12.5 billion) of market value.

The investigation is ongoing and, apart from Iran,  includes unlawful transactions with Libya, Myanmar, and Sudan.  Basically, Standard Chartered stripped and/or manipulated all wire transfer info that could identify the client as one on the US sanctioned countries list, so transfers would clear without setting off the US watchdogs’ alarms.

In its defense, Standard Chartered has so far said that:

… 99.9 percent of its transactions with Iran complied with U.S. Treasury regulations, and that the total value of trades that weren’t in compliance was less than $14 million.

$14 million vs $250 billion!  It is pretty obvious that $14 million worth of transactions over 7 years would have hardly generated enough fees to be worth the reputational risk.  Other than this, your guess is as good as mine.

I don’t know much about US legislature, but I would agree that the heavy-handed approach of the overeager and green1 regulator could weaken the case.  It is rarely a good idea to embarrass your superiors (FRBNY, Treasury, FBI), making them look dumb and sleeping on the job.  However, the eastern concept of saving face is rather foreign to westerners.  True, it can often be counterproductive by cementing the status quo.  But it can also lead to more civilized discussion and a more beneficial outcome for the parties involved.

It would have been easier and less dramatic not to turn the British defensive and force them to generalize recent American regulatory actions as a focused effort to harm London’s status a financial hub, smacking of protectionism.  After all, it’s an international issue and this is a 160-year-old British bank, not just any “rogue institution” that helped “terrorists, weapons dealers, drug kingpins and corrupt regimes.”

In the Salad Oil Scandal, American Express was just a victim of a skillful con man.  Here, Standard Chartered is the one that allegedly broke US law.  The cited internal communication indicates intent to deceive by withholding/obscuring transaction information.  Besides, banks are the big villains of today.  These facts point to the conclusion that this case won’t be easily dismissed.  However, the way the events are unfolding so far makes me think that the issue will be settled and Standard Chartered’s license won’t be revoked.

The Bank

The only reason I am paying attention to all the noise around Standard Chartered is the bank’s solid performance.

Standard Chartered has posted record profits each of the past 9 years.  It didn’t skip a beat even during the height of the crisis.  I don’t know what part of this is due to “funding terrorists” but Standard Chartered gives the impression of a very well-diversified bank, serving almost exclusively fast-growing, emerging markets.  The bank’s operations are well-diversified by both business and geography.  It seems unlikely that the non-compliant Iranian business is a large percentage of the total.  Yet, revoking the bank’s US license will most likely be a serious blow to its reputation and for its international operations.

In addition to its strong performance, Standard Chartered boasts a solid balance sheet and high capital ratios.  Tier 1 capital is around 14%.  However, due to the way Tier 1 capital is calculated2, I look at the crude measure of leverage (total equity to total assets).  Standard Chartered is leveraged about 15 times.  US banks are at around 10x after the crisis.  Overall, European banks are, and have been, more leveraged than American banks.  Fifteen times is actually conservative for Europe.

Looking at return on assets, it has stayed constant around 0.9% in the last 5 years and, with 15x leverage, return on equity comes at 12-14%.  While this is not stellar performance, it is way better than Standard Chartered’s peers – international banks like HSBC, Citi, Barclays, Santander, etc.

Earnings per share have grown at 7% each of the past 14 years, dividends per share – at 6%.  Equity and assets have doubled in the past 5 years.  Efficiency has been hovering around 55%.  This is close to the efficiency of Buffett and Munger favorites Wells Fargo ($WFC) and US Bancorp ($USB).

In this turbulent week, the price fell 30% only to recover 25% by the close of trading in London today.  As of now, the dividend yield stands at 3.7% and buyers would be paying about 20% premium to book.  This is not cheap, especially for a bank that has to a lot of explaining to do next Wednesday, August 15.  Nevertheless, Standard Chartered has a solid business.  In my opinion, the worst that may happen, if its license to do business in the US is revoked, is for it to be acquired.  Tighter regulation, higher taxes, slow or no growth in developed markets makes Standard Chartered’s business very attractive for any of the big boys and they will be happy to pay more than book, which is currently around £113 per share.  The stock closed today at £13.63.

In the interest of full disclosure, I bought some shares before the ex-dividend date and may be adding depending on how the situation and the price develop.

  1. The Department of Financial Services was created late last year by merging the New York State Insurance Department and New York State Banking Department. []
  2. It includes something called innovative capital.  It doesn’t only sound bad for a bank to have innovative capital, but also it is not clearly explained anywhere in the annual report what goes in there. []
  3. On Tuesday, August 7, $STAN set a low of £10.92. []