Standard Chartered IPO Analysis

Incorporated by the merger of The Chartered Bank and The Standard Bank, Standard Chartered Bank (SCB), with presence in India, Hong Kong and Shanghai for over 150 years, operates mainly in Asia, Africa and Middle East. SCB is an indirect subsidiary of Standard Chartered headquartered in London, United Kingdom.

With over 300 direct and indirect subsidiaries, joint ventures and associates, Standard Chartered is one of the leading international banking and financial services company and is listed on both the London and Hong Kong Stock exchanges. The company operates in two businesses: Wholesale Banking and Consumer Banking. The Wholesale Banking business provides corporate and institutional clients with trade finance, cash management, securities services, foreign exchange and risk management, raising capital, corporate and principal finance solutions. Consumer Banking products and services include banking services, deposit-taking services, credit cards, personal loans, mortgages, auto finance and wealth management services. For the year ended 31 December 2009, Consumer Banking and Wholesale Banking contributed 17% and 79%, respectively, of the company's operating profit before taxation and impairment. The Wholesale Banking portfolio is predominantly short term, with 70% of loans and advances having a contractual maturity of one year or less. In Consumer Banking, 61% of the portfolio is in the mortgage book, traditionally longer term in nature and well secured.

The Group manages its reportable business segments on global basis. The operations are based in 8 main geographic areas as follows: Hong Kong, India, East & South Asia, Other Asia pacific, Africa, Korea and America UK and Europe. As on 31 December 2009, the Group had 1,700 branches and 5,679 ATMs operating in more than 71 markets. However, Hong Kong and India are the two major markets of the company. Hong Kong is the key market for the company, with 77 branch outlets and 223 ATMs end December 2009. For the year ended 31 December 2009, Hong Kong activities contributed USD 2370 million operating income (16% to total) and USD 1062 million PBT (21% to total). India is the second key market, with 94 branches and contributing operating an income of USD 1813 million (12% to total) and PBT of USD 1060 million (21% to total) to the group for the year ended December 2009.

To increase market visibility & brand perception in India, provide new source of capital and support the company's growth globally, Standard Chartered is taping the Indian market with the first ever IDR (Indian Depositary Receipts) issue. An IDR is a mechanism that allows investors in India to invest in listed foreign companies in Indian rupees. IDRs are depository receipts denominated in Indian rupees issued by a domestic depository in India, and give the holder the opportunity to hold an interest in equity shares in an overseas company.

The company is to issue 240,000,000 IDRs at price band of Rs 100-115 per IDR by the book-building process, thereby collecting nearly to Rs 2400 crore to Rs 2760 crore. About 30% of the issue will be available for allocation to retail investors and less than 2% of the issue will be available for eligible employees. The bank has provided 5% discount on the final issue price to retail Investors. Ten IDRs represent one underlying share of the company and the new shares to be issued will constitute 1.16% of the post-issue paid-up capital of the company. Post-issue, the equity capital swells to USD 1026.7 million/ Rs 47.93 billion. The issue opens on 25 May 2010 and closes on 28 May 2010.

Business Highlights:

* In CY 2009, total business of the company leaped up by 10% to USD 458.54 billion owing to 8% rise in the deposits to USD 256.74 billion and 13% increase in advances to USD 201.80 billion. The credit to deposit ratio stood at 78.9% in CY 2009.
* Low cost current and saving account (CASA) balance comprises 53% of the total deposit base, up from 43% in CY 2008. The CASA balance grew strongly by 34% to USD157 billion in CY 2009.
* NII in the consumer-banking segment fell by 8% owing to lower interest rates, while NII from wholesale banking rose by 17% during CY 2009. Dip in the cash management and custody business was compensated by the trade and lending business with re-pricing actions. As a result, overall NIM of the company fell from 2.5% in CY 2008 to 2.3% in CY 2009. NIM of the company in 8 different geographies are as follows: Africa 4.8%, India 3.8%, East & South Asia 3.7%, Other Asia Pacific 2.3%, Hong Kong & Korea 1.8% each, and America UK and Europe 1%.
* Net fee and commission income grew by 15% to USD 3370 million driven by wholesale banking income owing to strong corporate advisory income and capital market fees.
* Loan loss provisions for CY 2009 were up by 51% to USD 2000 million.
* India joined Hong Kong as the second geography to deliver operating profits in excess of USD1 billion.
* Normalized return on ordinary shareholders' equity was 14.3% in 2009 compared to 15.2% in 2008
* Risk weighted assets (RWA) increased by USD 25 billion or 13% compared to 2008, largely driven through Wholesale Banking, whose RWA increased by USD24 billion, or 18%. RWA growth was concentrated in Singapore, Hong Kong and MESA.
* As against the GALCO (Group Asset and Liability Committee) target of Tier 1 and total capital ratios within a range of 7 to 9% and 12 to 14%, respectively, total capital adequacy ratio end December 2009 was 16.5% and Tier 1 capital ratio was 11.5%. In the corresponding previous year, total capital adequacy ratio was 15.6% and Tier I capital was 9.9%. The Core Tier 1 ratio at end of CY 2009 was 8.9%.
* NAV per equity share on consolidated front jumped up to Rs 630.24 (USD 13.5) in CY 2009 as against Rs 340.80 (USD 7.3) in CY 2008.

Asset Quality:

Asset quality of the company according to its major segments is as follows:

* Consumer Banking Segment: Gross NPA declined by 10% to USD 1252 million while Net NPA sharply declined by 51% to USD 195 million in the year ended December 2009.
* Wholesale Banking Segment: Gross NPA jumped up by 70% to USD 2760 million, while Net NPA has leaped up by 52% to USD 956 million in the year ended December 2009. The provision coverage ratio increased to 65.4% from 61.0% a year ago. The spike in NPA is driven by a small number of individually significant accounts, the largest of which are two closely linked customers in Saudi Arabia, included within the MESA (Middle East and Other South Asian) region.

On overall basis, Gross NPA leaped up by 33% to Rs 18728 crore while Net NPA increased by 12% to Rs 5373 crore in CY 2009. On the other hand, the ratio of Gross NPA to Advances stood unchanged at 0.6% while the ratio of Net NPA to Advances improved by 30 bps to 2.0%. The provision coverage ratio stood increased at 71% in CY 2009 from 66% in CY 2008.

Strengths:

* Strong Capital Adequacy Ratio of 16.5% supports the bank for meeting time liabilities and other risks effectively.
* The bank enjoyed higher CASA ratio at 53% in CY 2009, thereby supporting higher NIM.
* Presence in developing markets like India, Africa and China will increase the opportunities for the bank to increase margin and market share and strengthen its presence.
* Although the bank is headquartered in the UK, the total share of America, UK and Europe as a whole constituted only 12% of the total Operating Income at USD 1800 million and only 7.3% of the total PBT at USD 375 million in CY 2009.

Weaknesses:

* Changes in exchange rates affect, among other things, the value of the company's assets and liabilities denominated in foreign currencies as well as the earnings reported by the company's non- US dollar denominated branches and subsidiaries. A sharp fall in the value of the US dollar could also impact trade flows and the wealth of clients holding US dollar-denominated assets, both of which could have an impact on the company's performance.
* The company operates primarily in Asia, Africa and the Middle East, and these operations expose it to risks arising from the political and economic environment in these areas.
* The company operates in a highly regulated industry. Changes in bank regulations and laws and regulations in different countries could have an impact on its operations or impair its financial condition.

Negatives of investing in IDR:

* The IDR market India is in a very nascent stage. So, there is no assurance for liquidity on the BSE and the NSE.
* Due to the factors related to the application of provisions of English law and the potential application of certain provisions of Indian law; IDR holders are unlikely to be able to receive additional shares from the company in a rights offering or a bonus issue of shares or following an election made, at their option, to receive scrip dividend from the company.
* The IDRs are not fungible with shares and there are restrictions on the withdrawal of shares from the IDR facility, including an absolute prohibition on withdrawal of shares for a period of one year following the date of the issue of the IDRs. In addition, each IDR holder will have to individually seek the approval of the RBI for any withdrawals following the end of this one-year period and the process for seeking such approval remains unclear at present. Further, residents in India are only permitted to hold the shares for the purpose of sale and are required to sell them within 30 days following withdrawal.
* Holding as well as trading in IDRs is not tax efficient as per current laws as (a) secondary trading of IDRs is not subject to the Securities Transaction Tax (STT) and, hence, higher capital gains tax will be payable. (b) Dividend distribution tax is not payable by the issuer company and, hence ,dividend will be taxable in the hands of the IDR holders.

Valuation:

Standard Chartered annualized EPS for CY 2009 on post-issue equity works out to Rs 79.5 per share or Rs 7.9 per IDR. At the price band of Rs 100 to Rs 115 per IDR (without considering discount of 5% to retail Investors) P/E of IDR is 12.6 to 14.5 times. Taking in to account, the premium from the fresh IDR issue, post-issue Book Value per IDR is Rs 63.7 and Rs 63.9 at issue price of Rs 100 and Rs 115, respectively. P/BV at both the bands works out to be 1.6 and 1.8 times, respectively.

Comparing Standard Chartered with any Indian bank will not be proper as none of the Indian banks has scale of international operations as Standard Chartered. Moreover, the peer group for Standard Chartered will be global banks and not Indian banks and, hence, the price of the Standard Chartered share will be decided on other global exchanges.

The current share price of Standard Chartered on the London Stock Exchange (LSE) is 16.20 GBP (Rs 1092.22) and on the Hong Kong Stock Exchange (HSE) 185 HKD (Rs 1110.00). The three-month, six-month and one-year average price on the LSE is GBP 17.21, GBP 16.20, and GBP 15.27, respectively, while that on the HSE is HKD 202.29, HKD 196.65 and HKD 192.1, respectively. The average three-month, six-month and one-year premium/discount on the HSE compared with the LSE is 0.3% premium, 1.61% discount and 0.6% premium (with a range of -6.2% to 7.3% in the one year period ended 23 May 2010).

The Indian IDR can trade at premium/discount to price on LSE/HSE depending on liquidity and interest in the scrip on Indian exchanges. Notably, domestic insurance companies, which are major investors in banks, cannot hold IDRs. FIIs may prefer buying Standard Chartered on the HSE or the LSE, especially due to restricted fungibility of IDRs in India. Retail/HNI investors may also not prefer Standard Chartered IDR due to higher taxes involved in holding and trading.

Moreover, Indian investors have enough choice with so many Indian public and private sector banks listed and the domestic growth story considered as far superior and safer than the global growth story. Hence, the possibility of IDRs trading at discount to the HSE/LSE is high.

The price of the Standard Chartered IDR on Indian stock exchanges will be substantially determined by the prevailing price of Standard Chartered on the LSE and HSE and relative exchange rate between UK, Hong Kong and Indian currency. Global economic, political and stock market conditions will have more influence on the IDR price than Indian economic, political and stock market conditions. If the IDR gets priced near the prevailing market prices on LSE/HSE, the 5% discount to retail investors will leave little cushion in view of the high volatility currently prevailing in global markets and possibility of IDR trading at discount to the LSE/HSE share prices post listing.