09.08.2016, 19:11
Fitch: Low Standard Chartered ROE Factored into Negative Outlook
OREANDA-NEWS. Standard Chartered's announcement on 3 August that it expects to take longer to achieve its targeted return on equity (ROE) levels due to slowing global growth is not surprising and the delays are already captured in the Negative Outlook assigned to the bank's 'A+' rating, says Fitch Ratings. However, further delays in implementing its strategic plan could slow the chance of revising the bank's ratings outlook to stable.
Results for 1H16 show a return to modest profitability but a ROE of 2.1% falls well below targets - 8% for 2018 and 10% by 2020 - announced by management in November 2015 when the new strategic plan was launched. Management highlights external factors, such as low rates, slow growth in key markets and weaker global trade volumes, as being key drivers of sluggish 2016 results. But , in our opinion, internal factors such as implementing the organisational changes and having added new management could also play a part. The plan may have been over ambitious at the outset.
The size of the planned restructuring - USD100bn, equivalent to one-third of risk weighted assets (RWA) - and the targeted performance goals look increasingly high in the context of a competitive landscape and a slowing operating environment in Asia. That said, operating income has stabilised and was up by 3% in 2Q16 compared with 1Q16. Loan growth, up 3% in 2Q16, will be an area to watch as the bank applies tighter risk tolerance.
We think that winding down Standard Chartered's legacy loans could take longer because the task is complex. This could weigh on profits because the unreserved portion of the legacy book is a high USD4.2bn and the liquidation portfolio still holds USD7.3bn of loans of which 93% are non-performing. The bank has offloaded less than 10% of risky loans out of a total USD8bn portfolio earmarked for liquidation and management says they expect to exit the majority of positions by end-2017. In our opinion, conditions for offloading higher risk assets are unlikely to become easier.
Cutting costs is far easier than boosting revenues and about half of the total planned USD2.9bn cuts have already been implemented, generating 13% savings year-on-year. But income across all units contracted during the year to end-June 2016. This is a key concern because building up capital through retained earnings is an important rating driver. Boosting the profitability of relationships with key corporate, institutional and commercial customers is a core objective. Thirty per cent of identified low-return client relationships out of a total USD50bn pool have been addressed but tough market conditions influence client activity meaning that managing relationships towards the targeted returns becomes a more difficult task.
Reducing overheads at the Korean operation has helped to achieve breakeven but sustainable profitability is a challenge. No solution has yet been reached to consolidate the Indonesian operation into a single presence; in our opinion, this reflects lack of alternatives and the lengthy discussions with Indonesian authorities. Indonesia has proved to be a difficult market for foreign banks.
Standard Chartered has exited cash equities and equity derivatives businesses. Additional exits, totalling USD0.6bn out of USD5bn of identified RWAs for disposal, were achieved but in our view these are small and bring only gradual benefits to the bank.
The stock of non-performing loans (NPL) is stable at USD12.8bn but NPLs are rising in the group's corporate and institutional banking portfolios, which include the largest exposures and where concentrations can expose the group to unexpected losses. Overall asset quality is weak relative to the bank's rating level. NPLs represented 4.8% of total loans at end-June 2016 and only 53% of these are reserved. China exposure has performed well to date but a 12% exposure increase in the first six months of this year means it is now USD56bn, equivalent to 1.2x group capital at end-June 2016. The increase is mostly to banks as Standard Chartered places liquidity with them. Other concentrations include exposures to commodities and India, respectively at USD37bn and USD33bn.
The common equity tier 1 capital ratio has improved reaching 13.1% at end-June 2016, in line with our expectations and our rating. This is a consolidated ratio and we are increasingly looking at capital fungibility and capital allocation for banking groups that have material subsidiaries in multiple jurisdictions. Standard Chartered's key subsidiaries are well capitalised and our ratings factor this in. Pressure on the group's flexibility to redistribute capital, triggered by weak internal capital generation for example, could be negative for the ratings.
Results for 1H16 show a return to modest profitability but a ROE of 2.1% falls well below targets - 8% for 2018 and 10% by 2020 - announced by management in November 2015 when the new strategic plan was launched. Management highlights external factors, such as low rates, slow growth in key markets and weaker global trade volumes, as being key drivers of sluggish 2016 results. But , in our opinion, internal factors such as implementing the organisational changes and having added new management could also play a part. The plan may have been over ambitious at the outset.
The size of the planned restructuring - USD100bn, equivalent to one-third of risk weighted assets (RWA) - and the targeted performance goals look increasingly high in the context of a competitive landscape and a slowing operating environment in Asia. That said, operating income has stabilised and was up by 3% in 2Q16 compared with 1Q16. Loan growth, up 3% in 2Q16, will be an area to watch as the bank applies tighter risk tolerance.
We think that winding down Standard Chartered's legacy loans could take longer because the task is complex. This could weigh on profits because the unreserved portion of the legacy book is a high USD4.2bn and the liquidation portfolio still holds USD7.3bn of loans of which 93% are non-performing. The bank has offloaded less than 10% of risky loans out of a total USD8bn portfolio earmarked for liquidation and management says they expect to exit the majority of positions by end-2017. In our opinion, conditions for offloading higher risk assets are unlikely to become easier.
Cutting costs is far easier than boosting revenues and about half of the total planned USD2.9bn cuts have already been implemented, generating 13% savings year-on-year. But income across all units contracted during the year to end-June 2016. This is a key concern because building up capital through retained earnings is an important rating driver. Boosting the profitability of relationships with key corporate, institutional and commercial customers is a core objective. Thirty per cent of identified low-return client relationships out of a total USD50bn pool have been addressed but tough market conditions influence client activity meaning that managing relationships towards the targeted returns becomes a more difficult task.
Reducing overheads at the Korean operation has helped to achieve breakeven but sustainable profitability is a challenge. No solution has yet been reached to consolidate the Indonesian operation into a single presence; in our opinion, this reflects lack of alternatives and the lengthy discussions with Indonesian authorities. Indonesia has proved to be a difficult market for foreign banks.
Standard Chartered has exited cash equities and equity derivatives businesses. Additional exits, totalling USD0.6bn out of USD5bn of identified RWAs for disposal, were achieved but in our view these are small and bring only gradual benefits to the bank.
The stock of non-performing loans (NPL) is stable at USD12.8bn but NPLs are rising in the group's corporate and institutional banking portfolios, which include the largest exposures and where concentrations can expose the group to unexpected losses. Overall asset quality is weak relative to the bank's rating level. NPLs represented 4.8% of total loans at end-June 2016 and only 53% of these are reserved. China exposure has performed well to date but a 12% exposure increase in the first six months of this year means it is now USD56bn, equivalent to 1.2x group capital at end-June 2016. The increase is mostly to banks as Standard Chartered places liquidity with them. Other concentrations include exposures to commodities and India, respectively at USD37bn and USD33bn.
The common equity tier 1 capital ratio has improved reaching 13.1% at end-June 2016, in line with our expectations and our rating. This is a consolidated ratio and we are increasingly looking at capital fungibility and capital allocation for banking groups that have material subsidiaries in multiple jurisdictions. Standard Chartered's key subsidiaries are well capitalised and our ratings factor this in. Pressure on the group's flexibility to redistribute capital, triggered by weak internal capital generation for example, could be negative for the ratings.
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