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.
- The Department of Financial Services was created late last year by merging the New York State Insurance Department and New York State Banking Department. [↩]
- 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. [↩]
- On Tuesday, August 7, $STAN set a low of £10.92. [↩]
This is a fantastic overview of the bank and its potential issues and upside.
I do have a question for you after reading though.
After reading the Greatest Trade Ever, reading many articles and seeing several interviews with bank management after the financial crisis in 2007, and seeing how little they knew about what was going on, or the risks of some of the trades, personally I would not buy into any big bank. If top management in these banks do not fully know what is going on in its bank, how am I supposed to feel comfortable investing in it.
A more recent example from Mr. Dimon, CEO of JP Morgan, after its recent $2.5 billion trading loss said that he did not fully understand the risks of the trades his company was involved in.
What are your thoughts about how to account for those unforseen risks at big banks?
Thank you for your time and thanks for the fantastic write up. I am very interested to see your thoughts.
Jason,
I think it would be rather difficult to find a large organization of any type that doesn’t have problems controlling its employees and holding its operations up to high ethical standards. Even Warren Buffett’s favorites – Coca-Cola, Wells Fargo, IBM, American Express, Walmart – have all had their transgressions. Even at Berkshire they had the Sokol issue.
It is human nature. Our emotions get out of control. Operations get out of hand. Happens all the time. (Smart) people can and do do dumb things.
Then, it comes down to deciding how big the blow was and how strong the business is. Will it break?
I think Standard Chartered has solid operations in many desirable markets around the world. These operations are worth what they were worth before the scandal. If Standard Chartered’s reputation gets irreparably hurt by this transgression, the good part of the business will be taken over by some other bank. This bank will probably be willing to pay a fair price to have these operations.
I don’t have any special insight into the merits of the case. I’ll be keeping an eye on it because it will be interesting to see how it turns out. But I am not betting on a specific outcome. I just think the worst outcome is not as probable and as bad as it was first perceived, when the price dropped 30%.
I also find it strange that JPM was suddenly worth $60b less than WFC because of the trading/hedging scandal.
We have to remember though that while banks may have started as conservative concerns, today their convoluted operations and high leverage classify them for the speculative rather than the investment category.
All are very well put points.
I think my biases against big international banks that I learned when I first started learning about investing are just still too ingrained in my thinking to be objective about them at this time.
I will have to work on overcoming some of my biases because I do think that a lot of smaller community and regional banks, and even some big international ones would make some very good investments. Warren Buffett has made a lot of money from his Wells Fargo bet for example.
Hi,
At the beginning of 2012 Stanchart was on my shortlist as nr. 1 bank to invest in.
It still is.
The Iran scandal provided an excellent buying opportunity, like what Libor did to Barclays.
What I like about Stanchart:
I see how they have been doing in Africa over a decade, and I learned that they have a solid moat and much better internal controls than their competitors.
Stanchart charges their customers a lot for each and every transaction (non-interest income on their African operations must be huge), while at the same time demanding big (at least for the local population) opening balances for an account, i.e. they do not target low-level, microfinance-like clients.
Banking with Stanchart is like a status symbol for the middle classes.
Result of all the above: big profits. In Kenya, profit jumped y-o-y 60%, despite the fact that it had already been the most profitable Kenyan bank for ages.
And what I like most, is that their earnings there are not correlated with the economies of developed countries.
What I don’t like, is the over-exposure to Asia. If there is a serieous slowdown in China/HK, Stanchart must be negatively affected by it
Thanks for sharing your thoughts, Panly.
I share your view of STAN as a solid bank. Every time a company earns that desirable place in people’s minds – either as signifying high status or some other pleasant association – we are looking at a great business.
Asian exposure has been a big plus so far. In a similar way, their solid base in Africa may prove to be the new strong growth engine. Besides, if China dramatically slows down, it will affect everything, especially now that economies everywhere are in the doldrums. It is hard to guard against it.
Meanwhile, the probe seems to be expanding instead of dissipating.