Big might be beautiful
February 27, 2019

Blain's Morning Porridge 

"Big might be beautiful… but not always"

What's been the big corporate story of 2019? Perhaps it's how close GE got to the edge. new CEO Larry Culp is hastily divesting parts of the broken conglomerate, once America's premier AAA name, raising US$21 billion by selling its Biopharma unit and $3 billion dumping its loco business this week. It gives GE some flexibility and time to evolve into a new niche.. whatever that turns out to be. How the mighty are fallen.. Ozymandias indeed. Yesterday, I was reminded of the punchline – "Look upon my works ye mighty and despair".

Instead of writing the Porridge, I found myself blathering about Standard Chartered Bank's rather underwhelming results and lacklustre new "strategic plan". I don't buy it. It promises "Jam Tomorrow", but I doubt there is any real prospect it will ever be delivered. STAN and HSBC both suffered from Asian weakness at the end of last year. Both proudly point to the legacy of their Asian strength (where HSBC makes 90 percent of its profit), but are reticent about the enormous challenges they face as Asia evolves.

My thesis is simple: I suspect the "British Banks in Asia" bubble has burst, (probably a long time ago), and these names just don't realize it yet. The conventional wisdom is STAN will do well because of its mastery of emerging markets and Asian markets, while HSBC is now so big, dominant, and SIFI (systemically important financial institution) it will always win through.

Although a global slowdown might have short-term negative effects on both, long-term they are poised to do well from diversification - when Asia is suffering a slowdown, growth slows to 5 percent! compared to a European "boom" when growth rises over 1 percent! What's not to like? Asia is where the money is, and the oriental economies will soon surpass the broken occident. 

If so, why are STAN and HSBC stock prices declining? Analysts ask complex and detailed questions about net interest margins, tax and free capital, but what I read is the market pricing two tired institutions approaching the end of their natural cycle. Just like GE! 

Shock horror! It's heresy to question the Asian money-tree credentials of Britain's "finest" banks? Wake up and smell the chai!

Strip out the noise and the promises to double return on equity in STAN's results presentation - it's a bank in deep trouble and nowhere to run. It's pulling back from regions where it's underperforming – including the major markets in the UAE, Indonesia, India (the largest potential customer base on the planet) and Korea. It's selling a minority stake in its key Indonesian partner to free up and rationalize its capital – so it can look a stronger bank. And it's raising cash so it can mount stock buybacks. How imaginative.

What else can it do to reverse a ten-year decline in its stock price? It trades at a massive discount and is trying to break into the already very crowded high net worth space in Asia.. (who isn't?) while looking to digitization to build a retail business in Africa.

Digitization makes sound financial sense – but it's not easy. Especially in old, bureaucratic institutions with multiple numbers of legacy platforms and regional HQs struggling to remain relevant while declaring they are reinventing and innovating for the modern age. And it's not as if retail customers remain sticky high-margin depositors anymore if every fintech new-bank startup can do it better! Where does STAN go from here? 

Even more interesting is HSBC. Once it was the World's Local Bank. I'll be impressed if it comes anywhere close to meeting its recent ROE promises to get to 10 percent. It likes to talk about its pivot to Asia, but I suspect it's simply been lazy - using its easy Asian money to justify giving up elsewhere.

It's easy to please shareholders by pivoting to where it's making 90 percent of its money – which may explain why the UK retail bank is so awful and the US bank essentially unfixable. HSBC claims its DNA – many of the senior management are HSBC lifers - gives it unique strength and insights. My own suspicion is it's become inbred.

How sticky are the Asian earnings of HSBC and STAN? I don't think the future of finance bodes well for the last British banks in Asia unless they dramatically evolve. We all know Asia is where the new billionaires are – that's why every other investment bank, private bank and wealth manager has also "pivoted" to the region.

Its markets are developing rapidly, and maturing…which means new businesses, and quality of execution, are becoming critical. Do them well and fast, and thrive. Approach them as a bureaucrat and fail. As economies mature, growth will moderate and the demand for services will change. 

Perhaps the world's fastest growing financial market – Chinese corporate debt – isn't one to jump into, but experience shows finance moves from banks to non-bank lenders as the market economy matures. US banks get the disintermediation threat and arb it. I'm not sure the Brits know it's even happening. 

In other areas, like private banking and corporate, Asia is a very competitive space that favours excellence, profile or government-sponsored banking. HSBC and STAN are generalists and can't claim premier league status in any of these. Dare I say it, but HSBC is about the last symbol of colonial days left on the Hong Kong skyline. That does not guarantee it longevity in an increasingly competitive market.

Both HSBC and STAN need to spend billions on tech and management – perhaps it might make sense to do it together?  And then exit the region before it leaves them behind? If not, then I suspect STAN is not long for this world and will be snapped up by a Singapore suitor. Long term I doubt HSBC as an Asian bank lasts forever.  Suggesting HSBC might be something of a big, lumbering bureaucratic dinosaur – unless it demonstrates an as yet undiscovered talent for change – is going to get me a spate of angry emails. But take a look at the stock price – down 20 percent in a year. It's off my wish list. 

Bond Markets 

I've read a very interesting new comment from the OECD on corporate bond markets – which is where I got the info on China. The key points:

Corporate bond issuance has dramatically increased from $864 billion average over the ten years pre-crisis to $1.7 trillion in the ten years since the crisis. Outstanding issuance is now $13 trillion - $4.2 billion is due for repayment in the next three years! Large increase in BBB part of market and a decline in corporate covenants.

$500 billion of investment grade corporate debt could migrate to junk within one year – creating possible debt shock from forced sellers.

In the event of an economic downturn, significant difficulties for highly leveraged companies in servicing debt leading to lower future investment and rising defaults– which may "amplify" the effects of any downturn. Changes in monetary policy are highly likely to impact bond market dynamics

Sovereign debt borrowing is set to reach new record levels. 

Out of time, and back to the day job…

Bill Blain

Strategist

Shard Capital





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Blain's Morning Porridge 

"Big might be beautiful… but not always"

What's been the big corporate story of 2019? Perhaps it's how close GE got to the edge. new CEO Larry Culp is hastily divesting parts of the broken conglomerate, once America's premier AAA name, raising US$21 billion by selling its Biopharma unit and $3 billion dumping its loco business this week. It gives GE some flexibility and time to evolve into a new niche.. whatever that turns out to be. How the mighty are fallen.. Ozymandias indeed. Yesterday, I was reminded of the punchline – "Look upon my works ye mighty and despair".

Instead of writing the Porridge, I found myself blathering about Standard Chartered Bank's rather underwhelming results and lacklustre new "strategic plan". I don't buy it. It promises "Jam Tomorrow", but I doubt there is any real prospect it will ever be delivered. STAN and HSBC both suffered from Asian weakness at the end of last year. Both proudly point to the legacy of their Asian strength (where HSBC makes 90 percent of its profit), but are reticent about the enormous challenges they face as Asia evolves.

My thesis is simple: I suspect the "British Banks in Asia" bubble has burst, (probably a long time ago), and these names just don't realize it yet. The conventional wisdom is STAN will do well because of its mastery of emerging markets and Asian markets, while HSBC is now so big, dominant, and SIFI (systemically important financial institution) it will always win through.

Although a global slowdown might have short-term negative effects on both, long-term they are poised to do well from diversification - when Asia is suffering a slowdown, growth slows to 5 percent! compared to a European "boom" when growth rises over 1 percent! What's not to like? Asia is where the money is, and the oriental economies will soon surpass the broken occident. 

If so, why are STAN and HSBC stock prices declining? Analysts ask complex and detailed questions about net interest margins, tax and free capital, but what I read is the market pricing two tired institutions approaching the end of their natural cycle. Just like GE! 

Shock horror! It's heresy to question the Asian money-tree credentials of Britain's "finest" banks? Wake up and smell the chai!

Strip out the noise and the promises to double return on equity in STAN's results presentation - it's a bank in deep trouble and nowhere to run. It's pulling back from regions where it's underperforming – including the major markets in the UAE, Indonesia, India (the largest potential customer base on the planet) and Korea. It's selling a minority stake in its key Indonesian partner to free up and rationalize its capital – so it can look a stronger bank. And it's raising cash so it can mount stock buybacks. How imaginative.

What else can it do to reverse a ten-year decline in its stock price? It trades at a massive discount and is trying to break into the already very crowded high net worth space in Asia.. (who isn't?) while looking to digitization to build a retail business in Africa.

Digitization makes sound financial sense – but it's not easy. Especially in old, bureaucratic institutions with multiple numbers of legacy platforms and regional HQs struggling to remain relevant while declaring they are reinventing and innovating for the modern age. And it's not as if retail customers remain sticky high-margin depositors anymore if every fintech new-bank startup can do it better! Where does STAN go from here? 

Even more interesting is HSBC. Once it was the World's Local Bank. I'll be impressed if it comes anywhere close to meeting its recent ROE promises to get to 10 percent. It likes to talk about its pivot to Asia, but I suspect it's simply been lazy - using its easy Asian money to justify giving up elsewhere.

It's easy to please shareholders by pivoting to where it's making 90 percent of its money – which may explain why the UK retail bank is so awful and the US bank essentially unfixable. HSBC claims its DNA – many of the senior management are HSBC lifers - gives it unique strength and insights. My own suspicion is it's become inbred.

How sticky are the Asian earnings of HSBC and STAN? I don't think the future of finance bodes well for the last British banks in Asia unless they dramatically evolve. We all know Asia is where the new billionaires are – that's why every other investment bank, private bank and wealth manager has also "pivoted" to the region.

Its markets are developing rapidly, and maturing…which means new businesses, and quality of execution, are becoming critical. Do them well and fast, and thrive. Approach them as a bureaucrat and fail. As economies mature, growth will moderate and the demand for services will change. 

Perhaps the world's fastest growing financial market – Chinese corporate debt – isn't one to jump into, but experience shows finance moves from banks to non-bank lenders as the market economy matures. US banks get the disintermediation threat and arb it. I'm not sure the Brits know it's even happening. 

In other areas, like private banking and corporate, Asia is a very competitive space that favours excellence, profile or government-sponsored banking. HSBC and STAN are generalists and can't claim premier league status in any of these. Dare I say it, but HSBC is about the last symbol of colonial days left on the Hong Kong skyline. That does not guarantee it longevity in an increasingly competitive market.

Both HSBC and STAN need to spend billions on tech and management – perhaps it might make sense to do it together?  And then exit the region before it leaves them behind? If not, then I suspect STAN is not long for this world and will be snapped up by a Singapore suitor. Long term I doubt HSBC as an Asian bank lasts forever.  Suggesting HSBC might be something of a big, lumbering bureaucratic dinosaur – unless it demonstrates an as yet undiscovered talent for change – is going to get me a spate of angry emails. But take a look at the stock price – down 20 percent in a year. It's off my wish list. 

Bond Markets 

I've read a very interesting new comment from the OECD on corporate bond markets – which is where I got the info on China. The key points:

Corporate bond issuance has dramatically increased from $864 billion average over the ten years pre-crisis to $1.7 trillion in the ten years since the crisis. Outstanding issuance is now $13 trillion - $4.2 billion is due for repayment in the next three years! Large increase in BBB part of market and a decline in corporate covenants.

$500 billion of investment grade corporate debt could migrate to junk within one year – creating possible debt shock from forced sellers.

In the event of an economic downturn, significant difficulties for highly leveraged companies in servicing debt leading to lower future investment and rising defaults– which may "amplify" the effects of any downturn. Changes in monetary policy are highly likely to impact bond market dynamics

Sovereign debt borrowing is set to reach new record levels. 

Out of time, and back to the day job…

Bill Blain

Strategist

Shard Capital



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