Carson Block, founder of Muddy Waters and renowned short seller, said that he was shorting Standard Chartered PLC (LON:STAB) (LON:STAN) back in May of last year, and it looks like the rest of the market is starting to catch up with his views. Jefferies equity analyst Joseph Dickerson has initiated coverage of Standard Chartered PLC (LON:STAB) (LON:STAN) with an Underperform rating.

“We expect Standard Chartered PLC (LON:STAB) (LON:STAN) to de-rate to 1x forward price/tangible book as revenue growth decelerates faster than expected and investors more fully appreciate the risk transformation seen over the past five years. The bank is not set up for deterioration in the credit backdrop and regulatory capital excess is thin,” Dickerson writes.

Block’s Standard Chartered short has already paid off

Anyone following Block’s short could have already cashed in, but Dickerson sees further problems as the trends that used to benefit Standard Chartered PLC (LON:STAB) (LON:STAN) are now the sources of growing concern. The high single digit growth that STAN has forecast depend on an increasingly competitive leveraged finance market, unsecured consumer lending that is coming under more regulatory scrutiny, and cooling mortgage markets in Asia ex-Japan. Dickerson thinks loan volume growth will fall from the 10% level of the last few years to just 3%, bringing revenues down with it.

Standard Chartered price performance 0114

Signs of credit deterioration

Block mentioned that he felt the market was misunderstanding the level of credit risk facing Standard Chartered PLC (LON:STAB) (LON:STAN), and that there were already signs of credit deterioration. Dickerson agrees that credit deterioration is serious downside threat to the bank’s stock price.

The issue is that Standard Chartered PLC (LON:STAB) (LON:STAN)’s loans have a higher average maturity, which has caused net interest income to form a larger proportion of revenues. “While there is nothing ‘wrong’ with this mix bias towards net interest income per se, it does underscore an increasing balance sheet intensity of the Wholesale Bank that investors may not fully appreciate,” Dickerson writes.

STAN loans by maturity

But the quality of those loans has also fallen. According to Standard Chartered PLC (LON:STAB) (LON:STAN)’s internal credit grades, only half of corporate loans were grade 1-5, and the proportion of the lowest grade loans doubled between 2008 and 2012. Dickerson estimates that the probability of default has risen from 1.8% to 4.0% over the same time frame, even though economic conditions have been stable or improving during that time.

Compared to its peers, the Standard Chartered PLC (LON:STAB) (LON:STAN) has higher NPL (non-performing loan) ratio with a lower coverage ratio, but its coverage ratio is also falling while its peers is growing, giving even more reason to be skeptical of Standard Chartered PLC (LON:STAB) (LON:STAN)’s optimistic guidance for the next few years.

corporate loans credit grade 0114 STAN v peers npl 0114