- by GJ Prasad
Know your commercial (KYC) banking
We’ve had two banks – Standard Chartered and ING – that have been under market spotlight for KYC/ML related issues & reported earnings and, in both cases, the underlying core operating performance in the retail/commercial banking units stood up well. And equity investors seemed to like what they saw while credit investors are still pondering about macro issues.
Becoming Standard (STANLN) Again
Standard Chartered Bank (STANLN), the EM specialist with a UK base, reported much better than expected earnings primarily driven by broad-based revenue growth and tight cost control. Underlying profit before tax was 25 per cent higher and statutory profit before tax (which includes restructuring and other items) was up 35 per cent. Another Asia-focused bank reporting positive jaws in operating performance.
Similarly to HSBC, STANLN’s strength is its retail banking presence in fast-growing Asian markets with a solid deposit franchise and any pick up in lending results in decent pre-provision income. Customer loans-to-deposit ratio of 68% is where the strength of the retail banking franchise comes from. Though overall profitability is still relatively low to the double-digit returns in yesteryears, it seems that the bank is starting to deliver decent returns (ROTE of 7.5%).
STANLN reports a CET1 ratio of 14.5% – a big improvement from 13.6% reported at the same time in 2017 reflecting organic capital growth and reduction in RWAs. A leverage ratio of 5.8% is strong to absorb any unexpected large loan losses from an economic slowdown in its key Asian markets.
From a credit investor perspective, although the bank’s fundamental profile continues to improve, the risk premium for EM exposure is what is going to determine valuation in terms of spread. And equity investors will probably want to see further stabilisation of the earnings momentum to re-rate its valuation.
Keep (ING) it Simple
ING reported Q3 earnings this morning and investors seem to like the simplicity of the underlying business model and overall ease in understanding the drivers of earnings. The bank’s stock was up almost 7% on the day despite the bank taking a large EUR 775m in settlement charges as underlying operating profits before taxes increased by 6.5% on a year-on-year basis.
With a cost to income ratio in the mid-50s area and cost of risk substantially subdued at 27 bps, the bank was able to deliver a solid set of pre-tax operating income and a ROE of 10.7%. But for the one-off settlement charges, this would have been an even better quarterly report.
As they say, sometimes, keeping it simple is the best strategy. ING focus is on its domestic Benelux markets and within that retail banking allows it to generate decent returns on equity but with good capital metrics. With a CET 1 ratio of 14% and a leverage ratio of 4.2%, the bank is well placed to handle potential downside risks. In addition, the estimated annualised pre-provision income of almost EUR 8 billion allows the bank to absorb unexpected spikes in loan losses.
After years of internal restructuring and unwinding of the bank assurance model, the bank is finally starting to show the benefits of its simple yet powerful business model. It is one of the few examples amongst European banks wherein AT1 looks attractive to own/hold given the defensive nature of the bank’s business model and ongoing capital buildup.
From a credit angle, especially in senior and LT2, ING is going back to its earning its “boring but defensive” tag.