Idea of the Week: Consider this Tier 2 Investment Grade Banking bond yielding over 5%

• Standard Chartered PLC (“SCB”) is a multinational bank headquartered in London, UK.

• The growth in income was driven by its Financial Markets segment benefited from the high levels of volatility in the markets.

• SCB projects NIM to be around 1.40% for FY22 and rising to around 1.60% in 2023.

• Given the current environment of high inflation, we think the STANLN 4.300% 19Feb2027 Corp (USD) provides a stable income during this time.

• The STANLN 4.300% 19Feb2027 Corp (USD) offers an indicative yield to maturity (“YTM”) of 5.31% with about 4.4 years to maturity.

Standard Chartered PLC (“SCB”) is a multinational bank headquartered in London, UK. It operates in 59 markets and more than 80% of its income is derived from Asia, Africa and the Middle East. SCB is primary listed on the London Stock Exchange (LSE: STAN) and is a constituent of the FTSE 100 Index.

1H22 financial highlights

For the first six months ending 30 June 2022 (“1H22”), net interest income for SCB increased by 8% to USD 3.6b. Other income improved by 7% year-on-year (“yoy”) on a constant currency basis (“ccy”) to USD 4.4b, resulting in total operating income of USD 8.1b. The growth in income was driven by its Financial Markets segment benefited from the high levels of volatility in the markets. Higher interest rates also drove higher income to its Cash Management and Retail Products segment. Deposits margins were higher due to the rise in rates and drove a 37% yoy increase in Deposit and Other income.

On the other hand, Wealth Management fell by 16% yoy due to the Covid-19 restrictions in SCB’s main markets in Hong Kong, China and Taiwan. The lockdowns restricted customer and sales activity and resulted in income from SCB’s Wealth Management business to fall to USD 988m (1H21: USD 1,200b). Investor sentiment was also weaker which affected market-sensitive products.

Looking at SCB’s performance in its 5 key markets – Hong Kong, Singapore, India, South Korea and China, income improved steadily except for Hong Kong. Hong Kong remains a key market for SCB as Hong Kong contributes to ~21.1% of its operating income. As Hong Kong still remains in lockdown, SCB will face further headwinds and challenges in its Hong Kong market.

Rising interest rates to benefit SCB

Banks benefit positively from interest rate hikes as banks will be able to boost its net interest margin (“NIM”). Banks borrow on a short-term basis and lend on a long-term basis. Therefore, when shorter-term rates increase, banks are able to earn a greater spread from the difference in interest rates.  

NIM for SCB increased by 10 basis points to 1.32% in 1H22. SCB expects to benefit positively from the increase in interest rates and guided NIM to be around 1.40% in FY22. Based on SCB’s estimates, the impact from the next 100 basis points (“bps”) change in interest rates will be USD 750m.

Looking ahead, SCB projects NIM to be around 1.40% for FY22 and rising to around 1.60% in 2023. The rise in NIM will be positive to net interest income as banks can generate more income from interest-bearing assets, providing a positive boost in its net interest income.

45% of SCB’s income is interest rate dependent. As mentioned previously, net interest income increased by 13% on a constant currency basis in 1H22. The increase in net interest income was driven by a growth in interest earning assets and risk weighted assets (“RWA”) optimizations. Interest earning assets grew by 1% to USD 565b (5% increase at ccy) compared to USD 557b in 1H21.  On top of that, the growth in NIM from the rise in interest rates also boosted net interest income.

We think the rise in interest rates provides positive tailwinds for SCB as the bank will be able to generate more income from interest earning assets. Looking ahead, as SCB’s main markets in Hong Kong still remain in lockdown, higher interest rates will bolster some of the slowdown of its Hong Kong business.

Solvency profile

SCB’s capital position still remains within their guided range of between 13-14%. CET 1 ratio for 1H22 was 13.9%, providing a buffer of ~370 bps (~USD 9b of buffer) above its Maximum Distributable Amount (“MDA”) requirements. Comparing to other EU banks, SCB has one of the highest buffer above its MDA requirements. RWA optimisation actions from SCB should bolster its solvency position. In 1H22, SCB managed to reduce USD 7b of RWA through RWA optimisation actions and targets further USD 22b of RWA optimisation within the next 2 years. Liquidity coverage ratio remained stable at 142% in 1H22 while deposits also remained stable at USD 465b.

Table 1: CET 1 ratios of EU Banks

Recommendation

SCB has an issuer rating of BBB+(stable) / A3(stable) / A (stable) from S&P / Moody’s / Fitch respectively. Its tier 2 notes are rated also of investment grade quality with ratings of BBB- / Baa2 / BBB+ by S&P / Moody’s / Fitch respectively.

The STANLN 4.300% 19Feb2027 Corp (USD) offers an indicative yield to maturity (“YTM”) of 5.31% with about 4.4 years to maturity. The tier 2 bond does not have a call date and will mature on the 19 Feb 2027.

Unlike our previous tier 2 recommendations, the STANLN 4.3% 2027s does not have a call date which allows for the bonds to have lower extension risks as compared to tier 2 bonds with a call option embedded in the structure of the bonds. However, the STANLN 4.3% 2027s like other tier 2 bonds have loss absorption features which allow the issuer to write-down the bond.

Given the current environment of high inflation, we think the STANLN 4.300% 19Feb2027 Corp (USD) provides a stable income during this time. We think SCB’s outlook still remains decent as higher interest rates will provide positive tailwinds to the bank. Its solvency profile still remains well capitalised and we do not expect CET 1 ratio to fall below its MDA requirements. 

Table 2: Recommendation

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a position in STANLN 5.375% Perpetual Corp (SGD) and STANLN 4.300% 19Feb2027 Corp (USD) and the analyst who produced this report holds a NIL position in the abovementioned securities.