A set of good results from an international bank is all too rare an occurrence in the current financial climate but Standard Chartered showed it is possible by announcing last month that income rose by 26% and profits by 13% in 2008. Chief executive Peter Sands explains how it was done. Writer Brian Caplen

Sceptics might argue that there was as much luck as judgement in Standard Chartered's positive 2008 results, which set the bank apart from the rest of the international financial sector. Standard Chartered is positioned in markets that, until recently, seemed relatively less exposed to the full force of the crisis – Asia, Africa and the Middle East – and its focus on basic banking businesses such as trade finance and cash management kept it away from the more troublesome and exotic areas of the capital markets.

Disbelievers might add that some underlying trends in the results pose cause for concern – a rise in non-performing loans and a fall in profits in the consumer banking area as the slump in Asian equity markets took its toll on the wealth management business in the second half of last year. Can Standard Chartered really expect to come through this year in such good shape as it came through last year?

Clearly, there will be huge challenges as leading Asian exporters such as South Korea and China start to feel the impact of the downturn. But what becomes apparent from speaking to Standard Chartered's group chief executive Peter Sands is how the bank began reacting to the crisis in a cautionary way very early on.

Improving collateral

Deals were restructured and the quality of collateral improved across large parts of the portfolio. The balance sheet has for a long time been conservatively geared and the asset-to-deposit ratio has always been less than 100%. It was improved further from 84% to 75% in the latter half of last year. And the Standard Chartered business model of focusing on core markets and core products dates back to 2002 and 2003, when UK and Latin American businesses that did not fit were jettisoned.

However, not all shareholders were entirely happy about Standard Chartered's performance during the bull market run that preceded the current crisis. They complained that the bank's earnings per share were only comparable to those of international banks operating in mature markets – saying that because Standard Chartered worked in the higher growth markets of Asia it should do better. Some felt that the cost-to-income ratio was not demanding enough.

Mr Sands, who is a veteran of McKinsey as well as the UK's foreign office, had to use all of his management and diplomatic skills to persuade them that his strategy was the right one. He admits it was not always easy.

"What we were able to do is simultaneously produce double-digit growth in income and profits while maintaining a relatively conservative business model," he says, sitting in an office in the new London headquarters that contains artefacts from around the globe. A relic that he particularly likes is part of a seawreck from the South China Seas containing ancient coins, and he ponders, humourously, whether the UK's Financial Services Authority would accept them as capital.

"The challenge that we face, and I don't pretend it has been easy, is balancing the resilience and strength of the balance sheet versus delivering near-term profits.

The other bit of the equation is how much do you invest for jam today versus jam tomorrow," he says.

"This is a complicated equation and we have had to engage with our shareholders and explain to them how we think about life and the world. If you go back and look at what we were saying at the beginning of 2007 and 2006, you will find that we were saying that risk was being underpriced. I wouldn't pretend we quite saw the full ferocity of the crisis, we didn't see that at all, but we did see enough to make us a bit wary of what was going on.

"We did have some shareholders who said to us 'you are in these rapidly growing markets and growing your EPS [earnings per share] by x amount and these other banks are in much slower growing markets and growing their EPS by relatively similar numbers', others would say 'your cost-to-income ratio is high relative to others', and that wasn't always the easiest thing to explain – except that, when it came down to it, the answer was: 'look at the degree of leverage in the balance sheet, the easiest way to improve your cost-to-income ratio is to leverage up the balance sheet'.

"We did, at times, get push-back from the shareholders, particularly on things such as cost-to-income ratio, but on the other hand we have some very supportive shareholders and we have worked hard to explain how we are going about running the bank," he adds.

Mr Sands says that Temasek, the investment house of the Singapore government which holds 19% of Standard Chartered, falls into the category of supportive shareholder. "We treat them like any other institutional shareholder, we have a very good dialogue with them. They have been very supportive," he says.

Temasek has been in the headlines during the crisis for other bank investments, such as those in Merrill Lynch and Barclays, which unlike Standard Chartered have been badly hit by market turmoil. The group's chief executive, Ho Ching, who oversaw the international expansion of Temasek, has announced she is stepping down and will be replaced by Charles Goodyear, the former CEO of Anglo-Australian mining group BHP Billiton, but Temasek has said that Ms Ho's departure has nothing to do with recent investment performance.

Core strategy

Mr Sands puts Standard Chartered's good performance down to its discipline in sticking to the core strategy, a strong focus on banking basics such as liquidity management and cost control, as well as a culture that emphasises co-operation between various businesses and encourages employees to highlight problems where they occur.

On banking basics, he says: "We have a history of operating in sometimes volatile markets where we couldn't always take liquidity for granted – so we have never taken it for granted and we have always worked on the principle of running all our markets with AD [asset-to-deposit] ratios of less than 100%, as well as continually stress testing and thinking about liquidity. As the world has deteriorated over the course of the past 18 months, we have been very actively managing the overall liquidity position of the bank, so it is certainly not an accident that we have ended up with an AD ratio of 75%.

"It has a cost but we have very deliberately made a trade-off between near-term P&L [profit and loss] and the quality of balance sheet. We have done that on liquidity and we have done that on the risk side. We have given up margin either for more security, or we have exited relationships and have pulled back on things such as high margin unsecured lending in some markets. We just came to the conclusion that in this kind of environment, in that balance sheet/P&L trade-off, it is unambiguously better to go for balance sheet," he says.

Extensive negotiation

This has meant trawling through the loan book and carrying out extensive negotiations with wholesale clients. Fortunately, most of the wholesale book is short term and with margins increasing in the current environment, Standard Chartered was able to give up some of that extra income in return for better collateral or structures.

"The thing that we have particularly done over the course of the past year is to really focus on security and on structure of transactions: unsurprisingly the probability of default of the wholesale book has increased but at the same time, through the restructuring of transactions, we reduced the loss given default.

"One reason we haven't had the impact of PD [probability of default] migration on capital, that some other banks have had, is because if you cross-multiply the two things, they roughly cancel out. We have been actively managing the quality of the book.

"We ask for more collateral and tighter covenants and, in an environment where clients are facing significant increases in risk pricing, there is room to trade-off a bit on margin versus quality of collateral and covenants.

"There are two reasons for doing it. One is that it is better risk management. The second is that under advanced stages under Basel II, you effectively get capital relief because the capital equation takes full account of the value of the collateral.

"One advantage we have is that our wholesale book is typically short tenor – 72% is less than a year in tenor and that means you can renegotiate both pricing and structure. We have been prepared to negotiate a trade-off between the structure of the transaction and the margin. At the same time, we have been increasing margins on our lending activity. On a risk-adjusted return basis we think we are in a better place than we would be than if we were just going for same structure, better margin."

Standard Chartered has also been active on the consumer side in adjusting its risk profile. "We are generally making a shift towards a more secured, less risky asset portfolio. We were doing that anyway [irrespective of the crisis] but have speeded it up. If you look at unsecured lending to SMEs [lending to small and medium enterprises appears in the consumer part of the bank because of the wealth management prospects of entrepreneurs], we have halved the rate of new booking.

"We are also being more selective and thoughtful about what kind of customers we want to bank and what kind of relations we want to have with them. In the consumer bank we have very much had a product-driven approach, and we are shifting towards a customer approach, focusing on things such as relationship pricing, bundled packages, etc. This isn't rocket science, other people have done it. We have just decided that at this stage of our evolution we want to move in that direction," says Mr Sands. "This fits well with our philosophy in the wholesale bank which is much more about deep client relationships that about many client relationships."

As to the charge that Standard Chartered has been lucky in its choice of geographies, Mr Sands says that the decision to focus on core markets was made six or seven years ago. "We pulled out of some businesses elsewhere. We did have a business in the UK and we did have broader businesses in Latin American, but in 2002/03 we decided we weren't just an emerging markets bank, we were a bank focused on Asia, Africa and the Middle East – that was the key decision at that point. The main logic was not trying to pick places that would do well or not do well but to focus on places where we have economies of scale and edge, which we know more about, have deeper relationships and we really understand the dynamics.

"We are in some markets that have been through some fairly tough times. We don't think our markets will always have the best performance in the world but we want to be in a position where we really understand what is going on."

Between markets

A key part of the Standard Chartered approach is to enable customers to work between different markets so that Indian and Chinese companies with investments in Africa can use the bank's reach to organise their business. The bank has added trade finance teams in Europe and the Americas so as to pick up increasing trade flows between, for example, China and Brazil, but is not interested in consumer or domestic wholesale in these regions.

The strategy culminated in the excellent results released in early March with income rising by 26% to $13.97bn and operating profit before tax 13% to $4.57bn.

But the question is whether it can be carried on amid the difficult conditions of 2009. A report by the analyst CreditSights says: "Behind the record profits, loan loss impairments started to rise substantially towards the end of the year, and the bank said there was a sharp increase in delinquency rates in consumer banking in the fourth quarter as economies slowed." New York-based stock broker and investment bank Keefe, Bruyette & Woods says, in a note: "All in all, we view the results as comforting, but bearing in mind that we are just at the start of the downturn, the outlook is more important."

Mr Sands says that the wholesale bank has continued to perform well in January and February and that levels of loan impairment are not higher than expected. The bank is also witnessing its deposits grow as customers favour quality and its market share in areas such as trade finance is growing faster than the shrinkage in overall market size.

"We are benefiting on both sides of the balance sheet – deposits grew by 31% in 2008 and on the asset side of the balance sheet it is allowing us to reprice and restructure transactions. The competition has been disappearing faster than demand and that allows us to simultaneously increase margin and market share."

Organic Growth

Almost 80% of Standard Chartered's income growth came from organic business in 2008, which is typically the case every year, and another factor making Standard Chartered's figures a safer bet than those of rivals because growth by mergers and acquisitions is always fraught with pitfalls and problems. There may also be opportunities ahead to pick up assets cheaply but Mr Sands stresses his cautious approach to doing this in a risky environment.

On Standard Chartered's shopping list during the past year have been American Express Bank, purchased in February of 2008, the 'good bank' portion of Asia Trust and Investment Corporation in Taiwan last October, an upping of its stake in Indian securities arm Standard Chartered – STCI Capital Markets – and the acquisition of Cazenove Asia with the aim of offering Chinese corporate clients the opportunity to raise equity as well as debt with Standard Chartered.

Mr Sands rejects the notion that the bank is in any way 'hunkering down' as markets continue to dismay and even strong Asian countries such as South Korea start to face economic pain. "We are not hunkering down, we are very much open for business. I think the basic ingredients of what has served us well thus far will continue. The same strategy – it works, everyone understands it, we'll stick to it. The same focus on the basics of banking and some of the stuff is very granular, painstaking, technical, etc, but it makes the difference and stays true to our values and culture," he says.

"We want to continue to invest for growth, we want to continue to support our clients. The fundamental driver will be organic growth and we see lots of opportunities to win market share. We will look at acquisition opportunities but we don't think we need to do acquisitions. If you look at our record, 80% of the income growth last year was delivered through organic growth, and if you look at prior years it is always 70% to 80%, so we know we can deliver good growth organically."

The culture that Mr Sands wants the bank to stay true to is one of great diversity of nationalities, where open communication is encouraged and employees are encouraged to work together.

"We do run this place as one bank with short communication lines and a slightly informal, open communication culture – and that is very deliberate. We want short lines of communication and I encourage people to send me e-mails directly." Mr Sands says that part of Standard Chartered's culture is shamelessly borrowing good ideas from other banks and companies as well as studying reports of mistakes made in the corporate and banking world to see what can be learned from them.

The final factor in Standard Chartered, and indeed every bank's future success, is what happens on the regulatory front. Like most banks, he recognises that the sector has failed in some ways and that banking is now, inevitably, on the political agenda. What he hopes is that forthcoming regulation is not too heavy-handed and that the world does not balkanise financially as different countries respond to the crisis at a national level.

It would be harsh indeed if banks such as Standard Chartered suffered negative outcomes from a situation not the least bit of their own making. Where Standard Chartered can control its destiny however, one would have to feel confident about the bank.

Performance Highlights, 2008

Performance By Geography, 2008

Group Balance Sheet: Liabilities, 2008

Risk Weighted Assets ($Bn), 2008

Risk Weighted Assets ($Bn), 2008

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