Standard Chartered PLC (OTCPK:SCBFF) Q2 2016 Earnings Conference Call August 3, 2016 6:30 AM ET
Bill Winters - President and CEO
Andy Halford - CFO
Robert Sage - Natixis
Manus Costello - Autonomous Research
Martin Leitgeb - Goldman Sachs
David Lock - Deutsche Bank
Andrew Coombs - Citigroup
Fahed Kunwar - Redburn Partners
Michael Helsby - Bank of America Merrill Lynch
Tom Rayner - Exane BNP Paribas
Chris Manners - Morgan Stanley
Claire Kane - Credit Suisse
Good morning, everybody. Good afternoon for those on the phone. Thanks very much for joining us here. I know it's been a busy day. You've had one already announcing this morning, and giving some details. There are some common themes, so we won't we'll try hard not to repeat some of that. I would also like to properly welcome our new Chairman designate, who's not here in person, but is here in spirit; he won't actually start until October. And I'd like to take this opportunity, again, to thank Sir John for all that you've done for us. I know we still have six months to go, or five months to go together, so we won't say goodbye. But I would like to thank you for all you've done to make my first year certainly an interesting one, and an eventful one.
I'm going to be making a couple of comments upfront. I'll reflect on my first full year with the Bank. I'll hand over to Andy, who will make a number of detailed comments on our results. I'll come back and give a bit of a strategy update, progress, and areas for continued focus; and then, we'll have some time for Q&A.
Maybe, first and foremost, when I sat up here, probably, a year ago, but then most relevantly, probably, in November, I identified that at the end of our pretty rigorous strategic process I was convinced that we have a very strong valuable franchise with great client relationships that are enduring, through good times and bad. Obviously, not good or bad times forever, but ones that we could ride through. And that's exactly what I found in my first year of travels.
We set out a strategy in November that contemplated a challenging environment. The environment's probably a bit more challenging than we imagined at the time. But, nevertheless, we remain convinced that the strategy is the right one for our Group; and I'm not making material changes for the strategy, although we're continuously looking at refinement.
We've made really good progress on the strategic actions that we'd set out; I'll go through those in some detail later. Of course, we observed that the economies in which we operate, to a substantial degree, have slowed down; not all of them, but many have. That's had a consequent impact on our business. Continue to think, though, that the opportunities that we have to generate above-cost of capital returns are there; they're compelling.
And we've got the right people in place now. Our team has finally come in to something like its steady state. Simon Cooper was the last new addition from outside, joined about three months ago; that allowed us to move the rest of the organization around in to its resting place. The team is now in place. And I'm very happy to report that, as a team, its working very well, which you can never take for granted. But I'm very encouraged by the early signs so far. I'd just stress in my comment, before handing over to Andy, that every single decision that we're taking around our business, our strategy, our investments, our disinvestments are taken with a view of generating returns above our cost of capital in the medium to long term. That hasn't changed at all. And I think we're making very good progress.
With that, I will hand over to Andy; and I'll come back a bit later with some broader comments.
Good. Well, thank you very much, Bill. Hopefully, you have all got your packs here. I would just to observe, there is a slightly new format to the reporting in here, and the full document, rather than just a press release, is out with you a month earlier than last year. So, on to key numbers. 6.8 billion of income for the half year; that is clearly down a lot compared with the equivalent first half a year ago, but is only 2% down compared with the second half. And quarterly trends, a little more encouraging, which I'll come on to on the next chart.
Middle of this, in the red, 994 million, 1 billion of underlying operating profit, which plays about the same amount of underlying loss in the immediate preceding half year, albeit with the bank levy in it. But, nonetheless, if you normalize for that, loan impairment's a lot better; and expenses a lot better, good control in expenses.
And I'll talk to both of those a bit more in a minute. Small charges below the line, total restructuring now up to 2 billion, with 800 million also top up in the period; and, hence, a reported profit of 893 million. Normalized ROE, 2.1% so still some way from where we are seeking to it get to, but at least it does not have a bracket around it. Common equity Tier 1, at 13.1%, is where we were at the end of the first quarter, and up on the end of last year. And on the dividend, no proposal for an interim dividend; but that we will re review at the end of the year, consistent with the previous commitment so to do.
So, let's move then on to the quarterly phasing here. We've picked out three metrics, on the top, income; in the middle, loans and advances to customers; and on the bottom, deposits from customers. And you can see, going back over a six quarter period, that, broadly, the low point was around the end of Q4 2015, or in to the start of this year. And, in particular, on the income we have, encouragingly, seen small amounts of progress over each of the last two quarters. So, roughly, a 3% increase in the income in each of those two quarters, notwithstanding the fact that during the period we have tightened up on risk tolerances; we have been taking action on some of our low returning RWAs; we have got a negative income in the principal finance line; and, obviously, the backdrop in the economies has still been pretty tough. So, overall, I think encouraging that we are moving forwards bit by bit. Customer loans and advances are up by 5 billion since the end of the year; and customer deposits are up by about 13 billion over that period of time.
Let's just look at this from a client perspective. And I'll do this at a fairly high level, because Bill will talk about this in a short while. The four client segments, so this is half year profit for each sequential half year, our biggest profit contributor from retail at 431 million; and second biggest, from the corporate institutional banking at 239 million, which has been weighed down a bit by the principal finance performance. And then, commercial banking breakeven, so we're not out of that territory yet. But in terms of an improvement compared with the second half of last year, that is of the order of 650 million of improvement with a lot of focus on the integration of the business, and on the reduction of loan impairment charges. And then, private banking, 50 million profit. A difficult start to the sector at the start of the half year, but, nonetheless, I think, good progress, which Bill will refer to later on.
So, changing on to the geographic lens then, the four regions, as we all know, Greater China and North Asia being the biggest, and the biggest by way of profit contribution, at 722 million. The ASEAN and Africa and Middle East regions sort of vying for second place at about 350 million, so one 377 million, one 342 million. Europe and Americas, the numbers there look lower. A couple of things to note. First of all, some of the clients that went in to the liquidation portfolio, prior to them going in the portfolio we were booking the income in to the region, but since they've gone to the liquidation portfolio we deal with that all below the line.
And secondly, to remember that the remediation costs in the U.S. are clearly weighing down on the results in this part of the business to some extent. And I think it really is important to understand that this part of the business is very, very integral to the overall corporate business across the Group. Central and other, those things which are not directly within the control of those who run client groups, or those who run the geographies, have now been pulled out and are dealt with centrally. I am told, by Head of IR, that this Venn diagram is the clearest possible way to explain what is happening and you can ask him questions later, if it is not. Those that are in the middle parts are essentially common to both and those that are on the outer flanks are in one or the other lens.
So, just a couple of comments here. I've got a lot of numbers on it, I apologize for that. Probably, easiest just to focus upon the columns in red, just those are the most recent period. On the client segment, there is a profit contribution here over and above what the individual client segments have contributed at $285 million. That is primarily the ALM income of the treasury income in the center more than offsetting the corporate costs. Of course, in the first half we don't have the bank levies, so in the second half we'd have the bank levy going in as well.
And then, on the right-hand side, if you look at this in terms of the geographies then this is more about the losses in the principal finance business being the biggest reason why we have got a $471 million loss sitting in the geographic side of things. Then, again, similarly, at the end of the year we will have the bank levy that will go in to that category.
So, turning on to costs, I think, good performance here. The costs before regulatory costs are down 13% compared with the same period last year, so real traction there, even if we put the regulatory costs in still down 10% over that same period of time. So comfortably on track for the $1 billion of cost take-out that we said we would deliver. The top-left chart there in the dark green is the cost take-out through normal business activities, so not through divestment of the businesses. And you can see that that $1 billion is roughly double what we achieved last year and that itself was roughly double what we achieved the year before, so a very significant step up in efforts in this space.
But not just because of the cost take-out; this is also to fund some of the investments we're making, which, again, Bill will touch upon in a minute. But, particularly the roll out of digital in to some of the African markets, the start of the refurbishment of the privates and wealth management platforms, et cetera, a lot of effort going in to basically improving the fabric of the business as we move forwards.
Now, on to the risk side and the balance sheet, three key points here. The overall non-performing loans are fairly similar in aggregate to the numbers at the end of last year: They are slightly lower in the liquidation portfolio they are slightly higher in the business as usual, but nothing particularly untoward in there. The chart on the top left, let me just explain that one. In green, this is the liquidation portfolio and the loan impairment charges that were actually taken below the line, so the $968 million at the end of last year and another $200 million in to the first half. In the light blue are the loan impairment charges we took on the same accounts before we created the liquidation portfolio. So they went through our normal reported P&L at that time, purely because we had not set up the liquidation portfolio.
In essence, if you want to understand the business going forwards, it is the dark blue line here which is essentially the underlying of the business as we will see it in the future. So 862 million, then 1.5 billion, and now 1.1 billion, so, much as we were expecting during the period.
On the bottom left is showing the exposure management. Again, a lot of control particularly on concentration risk, so slightly lesser value of exposure to our top 20 clients, slightly less value on the commodities and producers and traders side. Overall, I think, the balance sheet and the risk control is in a satisfactory space.
Balance sheet wise, just a few factoids here, not to go through all of these. I'll come on to the CET1 in a minute. Total capital at 19.5%. We are 53% provided against non-performing loans, which is very similar to the end of the year; and, in fact, if you take collateral in to account, that's more like 67%.
Leverage ratio, it's in a good place. The MREL is already at around the 25% that we're going to need in longer term. And the balance sheet remains very liquid. So I think, balance sheet-wise, the story is a good story there.
Now, on the CET1s, 12.6% end of last year, 13.1% at the end of the first quarter, and 13.1% at the end of the year. There are various movements there. Part of this is profit contribution for the period, for dividends, that we have to take out for regulatory purposes, even if we're not paying them; and some of this is about the RWA management.
But 13.1%. And, as we said previously, there should be some upside on that once the liquidation portfolio is fully liquidated. But given where we're at, and particularly with some of the uncertainties in the regulatory space, particularly in the Basel IV space, we're happy to be running just slightly above range on that just at this point in time. And then, on the bottom here the risk-weighted assets, which have come down 10 billion from the end of the year; so they were 303 billion, and now 293 billion.
In summary, we set out the course in the strategy update in November. I think everything you're seeing here is very, very consistent with the delivery of that. It is early days, but the whole organization very focused now around what we need to do.
I think it is encouraging that we have seen the income trend stabilizing and just starting to move forward a little bit. I think it is encouraging to see that the costs are now under really good control, and the balance sheet is in good shape. But we do need to remember that the outlook and the external environment is still quite a tough place, which Bill will talk about in a second. Bill?
Okay. Thanks, Andy. This slide will, should look familiar to you; it's the set of actions and categories that we set out back in November to drive the transformation of the Bank. We're making good progress on every one of these things. I could be talking about any of them, but, in fact, I'm just going to talk about the ones that I've highlighted here, in due course. And as we go through periodic updates, we'll cover different areas where we've made some progress.
First, let's focus on the Group RWA restructuring. You recall, at the outset we said we would be, one way or the other, restructuring about one-third of the Bank's balance sheet. We made good progress on each front. Let's take them in turn.
First was the $20 billion of risk weighted assets that we identified for liquidation, the liquidation portfolio. The headline, you will have noted, has not gone down a lot from year end. I can report though, that we made very good progress on the bulk of that program. So we have a plan for every single asset in the restructuring portfolio. We have closed out some of those restructurings either through restructuring sale or other resolution. We have advanced plans on the bulk of the rest of the portfolio. But, as we've always said, we can't possibly declare victory until these deals are signed. Every deal is a complicated deal. Every day has an M&A component and there are many parties to many of the deals involved here.
So, not declaring victory are proclaiming good progress and I hope to be able to show that in the actual figures in the quarters and periods to come. Second, the $50 billion of low returning client relationships, again, good progress. We've restructured about $13 billion of the $50 billion of client relationships. Over half of those have remained with the Bank; the other half have left through one mechanism or other. The rest of the volume to be worked through, we have good plans and are advancing on those plans, so we think that we should see similar sorts of outcomes for the rest of that.
I will note, indeed you'll ask the question if you're doing such a good job in upgrading your client relationships why aren't the returns of C&IB higher? And the answer is that we are as challenged by the rest of the client population, income pressures, as well as some credit migration, as we are making progress on the population that we targeted. The game here, as it were, will be to continuously upgrade these client relationships. Obviously, a point of time will come when the external market is a bit more favorable and the headwinds will be less. But for the time being, we are running quite a bit forward, but the wind is blowing us a bit back at the same time.
The focus countries, Korea, very happy to report that we've now had two quarters of breakeven/small profits in our Korean business. That's on the back of very substantial expense actions taken at the end of last year as forecast. As well as the early stages of the alliances that we got with Shinsegae, largest retailer in Korea and the Samsung card business, where we have a joint venture in cards. So, beginning to see some real operational improvements there in addition to the cost efficiencies that we achieved last year.
Indonesia, discussions are ongoing. Very, I think, good natured discussions both with our partners and with regulators. I think we have a reasonably clear path on the way forward. It is complicated by the fact that the Indonesian economic environment is particularly challenging right now. But we continue to think that we will achieve the objective that we had set out of getting to a single-scaled operating entity in Indonesia. And the $5 billion of peripheral businesses that we sought to exit, good progress. We've had seven divestments since November. We're a little bit over halfway through that. The most recent exit that we announced was the sale of our retail business in Philippines. And we've got more in the works and of course, we'll report on that in due course.
Financial crime, we have continued to make this a top priority in the Bank, financial crime compliance and prevention. We've invested heavily, as you saw in Andy's slides and as we've said repeatedly. We'll continue to invest to get best-in-class systems and infrastructure. We have a long way to go to get to the point where we are satisfied ourselves. I can't make relative comments to other banks, but we intend to be the best-in-class to the point where it's a real competitive advantage for us and not just something we have to do. We're getting some recognition for the efforts that we've made. I'd say that the tone with our regulators is good. They've recognized the efforts that we've making; also, that we have further to go. We've been recognized by FinCEN in the US for having contributed materially to a couple of substantial financial crimes that they resolved on the back of some information that we provided and extensive analysis. This is very encouraging. Frankly, it's a good thing. It shows that we can make a difference. It's encouraging for our own staff to note that this very hard work that we're doing from time to time results in a really good effect in terms of bringing the actual bad guys in to the criminal justice system, where they, no doubt, belong.
We talked about the external investigations. I've told you I would report out each time I stand up here. I can report that nothing's changed. The investigations are ongoing. They're active. We know that. We're cooperating fully. And, again, when we have something to say, and when we have a better idea what the outcome might be, of course, we will share that. I'm going to do a quick run through the key business segments, to pick up on Andy's comments on the financials, and comment on what the real areas of focus are for us, and how we're progressing.
First, on C&IB, Simon's been on board about three months now. He has traveled extensively; he's met a lot of the people. He knows, knew the business well as a competitor, so he didn't start from zero. But he's developed some very clear ideas on how to take the high-level strategy that we set out in November and drive that through that C&IB franchise.
First is enhancing the coverage model, so that's eliminating duplication, it's refocusing our client coverage. I think it's simplified, I would say, towards the new economy and away from the old economy; we were old economy heavy in our Bank. We had some key wins with the new economy sector; we're talking about media electronics, the service sectors, and, of course, ongoing finance. Good progress on the, optimizing the below target risk weighted assets. We talked about that a moment ago. And putting on a much more active credit portfolio manager function, so focusing on managing our portfolio, both the incoming and outgoing, in a more dynamic way. So being more nimble, being more effective, and better uses of capital.
Building on our product capabilities; RMB, as you know, has been a key focus for us, and remains one of our real opportunities we see in the medium to long term. And, of course, the efficiency that Andy and his team have been driving throughout Bank is very evident in C&IB.
Retail; retail also making very good progress. Again, high level teams with a refocus increasingly on our growing affluent client population. That comes in two forms; one is the clients that we're targeting.
The alliances that we've set up with Asia Miles, for example, in Hong Kong has been a great success. We've got about 100,000 new accounts in the early days of that joint venture, with a substantial portion of those clients being priority clients. It's been one of the things that's helped our income in Hong Kong. So really focusing on that priority client segment.
Also, focusing from a geographic footprint-perspective. So, on the margin, moving branches out of the lower wealth and slower growth subsets of our local economies in to the urban centers, where wealth congregates.
The other big thrust on our retail side has been the digitization of that business end to end. We've got many best in class online banking systems today. If you live in these markets, you'll recognize that Standard Chartered online and mobile banking apps are, in many cases, regarded as the best in the market.
We get, awards surveys tell us that we're very good. Of course, we're not relaxed about that at all. We're investing heavily to make sure that we both cement those leads and extend. But we're also digitizing the rest of our process. Those are big investments. They're taking years, but we're very much on track.
Commercial banking is a more fundamental repositioning, as we said. As Andy pointed out, this was a big loser for us last year. As a business segment, it was created over the past two years. We've gotten that segment to scale now with the introduction of local corporate clients in to that commercial banking business line. That gives us scale; it gives us management depth. We've been able to seriously upgrade the credit skills of our frontline relationship managers. Always more to go. But we're in a much better place there to avoid the kinds of high loan impairment levels that we experienced over the past year or two.
Very focused on efficiency. We had a substantial CDD related client screening, and, eventually, exit process. We're largely complete with that, so now we're in the position to add clients, which we're doing at a good pace. We've got the people in place, we've got the management structure and we've got the franchise, we've got the products to grow this client segment which we will have to do to get from this breakeven position to something that is towards and then eventually, obviously, to our cost of capital.
Private banking, as Andy pointed out, tough first half of the year given the impact of market volatility on our clients. It also was a repositioning first half for us. We have a new management team in our private banking segment; super energized; very, very attracted to the Bank because they see an underdeveloped client franchise with a good strong set of underlying wealth and product capabilities that we can really exploit. They've been able to attract a large number of relationship managers, most of whom had not yet started. So we have an Indian team that has started but only a few weeks on the ground; a Greater China team, based in Hong Kong that has been appointed and announced, but won't start for another three months. So we'll begin to see the returns from those investments towards the end of the year.
But the fact is we have a very, very valuable franchise that is as yet, substantially underexploited. And we're looking forward to taking the new management team, the new relationship management focus, the existing wealth products which are quite good and well diversified, together with a substantial technology investment to make this a differentiated business in the Asia, Middle East and Africa region, but one which can go head to head with anybody.
The investment program, again, similar themes. We have our system systemic investments which are the $1.5 billion, substantially upgrading our existing capabilities, both to maintain franchise and extend on the margin and to go from lower margin sets of capabilities to more solutions-oriented capabilities. We've got the strategic investments which are similar themes; the digitization and end to end in retail, frontend, as well as backend; the investment in this wealth management platform that I just described. And within the wholesale bank, we have substantial investments improving our electronic connectivity with clients which is a real differentiator today. But it's several years old now, so we're upgrading substantially. And as well as piloting and testing some of the more cutting edge areas. So being at the forefront of the use of distributed ledger technology in trade finance, for example, where we have a discrete pilot and venture in Singapore.
On the regulatory side, in addition to the financial crime remediation program which is a substantial investment and will be for another couple of years, we've got the challenges of adapting to the new Basel Committee rules which is, of course, as yet somewhat uncertain and IFRS 9 an accounting standard which will have a material impact, both on our financial results, but also the systems required to produce those results. If I could just say quickly, in summary, really do continue to believe that we've got a great franchise; as yet, substantially underexploited. But we're taking the steps that are necessary to get to the maximum value out of this franchise that we've got.
The strategy is right for the business that we see in front of us and for the environment that we've got. Truly recognizing that relative to November of last year, when we stood up here and talked about our new strategy, economies are slower than they were at the time; the outlook for interest rates is lower; the pass-through to the income line and to the possibility of loan impairments, which of course remain elevated despite the fact that there's been some improvement period to period. We have a more uncertain environment, as it relates to regulation. And this combination of things causes us to say, not to back away from our progression of 8% ROE then through to 10% and then generating a return above our cost of capital, but we have to recognize, if nothing changes from here, it's going to take longer.
But I'll just repeat what I have said before, is that every investment decision that we're taking, every hold decision that we're taking, every divestment decision that we're taking is looked at through the lens of generating this cost of capital plus return. And you may ask the question, why are you out spending $1.4 billion of investments, reinvesting all those hard earned cost saves if you're not yet earning your cost of capital; in fact, are far away from it? And the answer is the investments that we're making are generating new returns that we want to generate.
We've got a stock that we need to restructure, and we are. And we're doing that with a tremendous determination, a lot of energy from a team which, frankly, is young and fresh and new. Even though some of us have been on this planet a long time, and others of us have been in this bank a long time, the team is super energized by the opportunities that we have. I couldn't be more positive on the opportunities and the potential that we have; equally, offset by some of the challenges that we know we face right now. So, with that, I will flip it over to you for Q&A.
Q - Robert Sage
Robert Sage, Natixis. A couple of possibly related questions. The first one is in terms of the phasing of the restructuring costs, which I think you said you were two-thirds of the way through. But most of that came through in the second half. Should we, looking forward in to the second half of 2016, expect to see $1 billion or so actually come through? Or should we be looking at a slightly longer phasing period? And the second, possibly related, question is in terms of the liquidation portfolio. You were mentioning the good progress being made. Do you think we should expect to see significant reductions in the outstanding balance of RWAs in the second half? Or, again, should we be looking at a slightly longer time period?
We're, obviously, monitoring the restructuring as we go. And back in November we said, give or take 3 billion, which was clearly an estimate at that stage. Some redundancy costs, some goodwill costs, some liquidation write offs. As you've seen today, we are at the 2 billion stage on that. I think, over successive months in the rest of the year we'll look at exactly where we get to. At the moment, I wouldn't change the directional statement on that. But, obviously, the devil will be in the detail, and we'll see what happens over the balance of the year.
Coming on the restructuring book, the liquidation portfolio, it's very hard to forecast the timing. What we said at the outset was we've got a collection of assets; each one is its own story. We're not going to waste shareholder money to get something done sooner rather than later. We're going to do the right deal for the Bank.
It's possible that the right deal means going back to business as usual. But, obviously, we didn't segregate it in order to have that outcome. But if that's the best outcome, upon reflection, and a lot of hard work, that's where we'll go. There's nothing that we've seen so far that suggests that that's the case, where I think we would call that out, but the timing is uncertain.
What I know is that in the seven months since we, or eight months, I guess, since we've stood up and made that statement we've made very good progress on the majority of the assets in that portfolio, to the point where we are very confident with the underlying carrying values. We've repeated, I think, quite clearly, that we think we can accommodate this entire restructuring within the budget that we set out; the $3 billion that we articulated at the outset. And we're very confident, asset by asset, that we are carrying these assets at a level that reflects where we could liquidate them, or where a plan B would result in a liquidation. So the timing is not the driver, actually.
Manus Costello, Autonomous. Bill, when you set out your plan and gave it an 8% ROE target we all thought you were being very cautious, and it wasn't terribly demanding. It turned out we were wrong and actually, it was somewhat overoptimistic. So looking out now, not being able to hit 8% in 2018, what are the levers that you will think about pulling if we remain in the environment that you've talked about, lower rates, slower growth in Asia? Because we're looking at a sustained period of substantially below cost of equity returns otherwise.
We ask ourselves the question all the time. First, is this a temporary phenomenon? Are we low for long? Or are we low forever in terms of GDP growth and interest rates and all the things that follow from that? We're clearly low for longer than we suspected would be the case when we set out the scenario in November. We also contemplated in November that things could be worse than we set out which is why we went in with such a strong capital position and why we continue to carry such a strong liquidity position. So we're not outside of the zone of outcomes that we thought were entirely possible and for which we were prepared. But the question is, at what point do we say it's not low for long, it's low forever? And we just don't see that.
You'll have your own view on the economic outlook. But, when we look around the world we see the formation of the platform for decent growth in the U.S. We see stability in China that was pretty manifestly not there at the beginning of this year; but there's policy consistency and there's transition that we have heard so much about and talked so much about, is actually happening and we see that on the ground. In no way are we declaring that we're out of the risk zone in terms of the Chinese transition, it's a very risky transition that they're politically and economically going through, but we see lots of encouraging signs.
We see great resilience in European economic activity on the back of the Brexit referendum. I'm not sure that we would have expected as much resilience as we've seen. Now, is there risk in Europe? Is there risk in the UK? Of course there is. And it's higher than it was before the referendum. So, accept that. But, nevertheless, the underlying signs of the opportunities for resumption of global growth are there. So we look at that and say, we're not in a low forever, we're in a low for longer than we anticipated and we've got to brave this out and continue with the investment plans that we had.
We're not thinking about plan B, because it's not consistent either with the value that we think we can generate from every investment that we're making right now and we think we're going to get good returns on the investments we're making in this market. But, of course, we're looking at it all the time and if we reach a different conclusion about low forever or worse, obviously, then we would have to look at something different.
Hi, it's David Lock, Deutsche. Three, please. The first one, on the ROE, when you originally came up with the target you had a 10% ROE, of course which is diluted by regulation. I wondered if you could update on whether your thoughts on the regulatory impact on Standard Chartered have changed at all in the months since November. And then secondly, on costs, it feels to me like you're ahead of your plan. I know you're flagging, in a very clear big blue box on the slide that you think the second half will be tougher than the first half, but you also have, probably a tailwind on FX, given Brexit. I wonder if you could talk about whether you feel you're ahead of your cost plan, and if there's any potential around that.
And then thirdly, on income, I think in the first quarter, you flagged that there is a heightened volatility that had led to a better performance in financial markets. I just wondered if that was the same in the second quarter and whether you expect that to continue. Thank you.
Maybe a regulatory effect, we set out back in November that there were a number of uncertainties. Of course, we have the uncertainties around our own investigations that's not regulatory that's us and then, there was the Basel IV or whatever we're calling it uncertainties. Those uncertainties, not only have they not been resolved, but they've probably widened.
So you've had more strident comments from various regulators, including the governor of the Bank of England, that there would be no material increase in capital requirements. And we have consultation documents from the Basel Committee that suggests, in some cases, substantially higher capital requirements. Which is right, how are those things going to be reconciled; we don't know. I do note that the stridency with which the comments have been made by the regulators around their intentions from a macro perspective are very clear, so that's encouraging. But how that jives with the consultation papers, and what it means for Standard Chartered Bank, as opposed to the industry as a whole, remain unclear. We built in a buffer, as it were, for that uncertainty. And as we sit here in August, I'm afraid, we don't have a much clearer picture. Hopeful, but not a clearer picture.
On the cost one, I think, we have got off to a good start. I think the whole ethos of cost and the importance of the reduction is really throughout the bloodstream of the business.
But equally, to one of the points Bill's made, income is still the thing we really have got to try to get going quicker, and, hence, to some extent, this is going to be about redeployment. And it's not just about the investment projects; those are coming onstream, hence, the blue box on the chart. But we just are thoughtful, if we can get the income to move, even if that means a bit more cost going in there, I think, that will be the better thing for the Group. So the statement we made in November that in 2018 the costs will be lower than 2015 we absolutely stand by. Whether it's going to be completely linear between the two, more debatable.
You also had some market volatility, I think. The, we obviously had the RMV]volatility earlier in the year, which was helpful for our business, a substantial increase in client flows. We had Brexit related volatility, however briefly, which was also helpful in terms of increased client flows. Are we going to have another interesting surprise like that in the second half? From a narrow FM perspective, I guess, we should hope for that. From a broader Bank perspective, I think we'd be okay with a boring second half.
Martin Leitgeb, Goldman. I have a question with regards to capital and capital deployment going forward. Number one, your capital ratio you've got today is similar to the first quarter, is above your target range. Number two, you are hinting that the growth might be somewhat slower on the back of the weaker macro. And just thinking forward on your capital progression, I think you hint that the liquidation book would add potentially 40 basis points of capital on top of where you are now. And in light of one of your competitors today announcing a share buyback, I was just thinking how should we think about what capital levels you would be targeting in the medium term, because obviously you follow. you're not strategic similar to the competitor to that degree? And equally, in terms of weighting potential in organic growth, I think you flagged that in some of the communication previously, the optionality with Indonesia and the optionality to return capital, if you could guide us a little bit how we should think about what equity component of that return on equity should be.
Yes, there are a few differences. One is doing a buyback, we actually did the rights issue a short while ago, so just to observe that one. No, look, we said 12% to 13%; and our view was that, taking account of various things still moving, sounded to be roughly the right zone. We're at 13.1%. We could be a little bit higher than that once liquidation portfolio has gone.
There are, in particular, a number of consultation papers floating round in the Basel space which have got somewhat different interpretations either from the papers themselves or from what regulators are saying about what their intent is. I think over the coming months that will become clearer, hopefully one way or the other, as to how it will all play out. Our view at the moment is that we're right just to be on the top end of the range. It is a comfortable place to be. There seems to be a general drift up in requirements. Stress tests, et cetera, come round. It is certainly more comfortable going in to those in a good position. So we're not in a rush to go and do something that would change us from that course, but some things may become clearer over the coming months, is how I'd look at it.
Do we have any questions on line?
Unidentified Company Representative
We do have a couple of questions online. The first two come from Stephen Andrews, Deutsche Bank. And the first follows on from David's questions around costs. The headcount was down in the second half of last year given the restructuring actions you took. It looks like it's on the increase again now. How should Stephen think about the mix within that other areas that you're still shrinking areas that you're growing? And then, following on to that, what does that mean for the outlook for costs in the second half?
The second question he has is on deposit income. It looks like it stepped up quite a lot in the first half of this year versus the second half and indeed, more so than the balance sheet growth. What's in that line? And how should he think about that given the low interest rate environment that we've talked about?
If I take the cost one first, I think, we will get a little bit higher costs coming through in the second half. We have got the investment spend coming through. But on the headcount side of it, whilst a big part of our cost base is headcount related, we are being thoughtful about how exactly we do manage the business. Last year we were down on heads overall. The first half to the question, we are slightly up about 400 up on heads and that is a mix of some roles that have gone and it is a mix of some investment in to new roles. So, in the retail space, as we have said, we're going to get a cost-to-income ratio down there overall. There are opportunities definitely to be reducing heads. But as we have said that we're going to be investing more in to the private wealth management platform, more in to Africa and other places, we are unashamedly, deploying more heads in to those parts of the world.
I think from my perspective and I know from Bill's, getting the costs is the really key one here. If we're doing rebalancing of heads within that then that is part of running the business and that's sort of where we're at. The second question was on which line?
Unidentified Company Representative
Deposit income within retail products stepped up in the second half, can you just talk a little bit about that? It's quite a meaningful step up and how we should think about that in the context of low interest rate environment.
Yes, we have been pushing quite hard to make sure that where we are sourcing funds that we are getting them from the lowest cost parts of the business and that they are reasonably sticky. And in the retail part of the business, clearly, we have a lot of customers with deposits with us and so on and that has been an area of focus. So, as we move forwards, the retail platform and what it provides to us by way of good enduring funding for the business is something which we are increasingly focused upon.
Thanks. It's Andrew Coombs from Citigroup. A couple of questions, please; one on asset quality, and one on capital. Firstly, there has been a small uptick in CG 12 loans, which I think you draw out as commodity-related sectors. Could you just provide a little more color there, please? The second question, just on the RWA progression relative to loans, if you look at C&I, RWAs are down 7 billion, loans are up 5 billion. Presumably, the majority of that divergence is because of the optimization of low returning assets. Overall, you've only done 15 billion of 50 billion, so should we assume that divergence will continue? Will it decelerate? What's the thoughts from here? Thank you.
I can comment on the credit quality question. We'd love to say that the challenges of the environment are behind us in terms of NPL, CG 12, and NI, but, clearly, we're still at a higher level than we would consider to be an acceptable state.
We have had a slight increase in CG 12 and non-performing loans. It's coming from a number of areas, but some overlap with the old chestnuts that we've identified, being commodity-related exposures, and India. I'd say the oil service sector has, in particular, been challenging, for all the obvious reasons. So, lower commodity prices for a longer period of time will continue to impact that line. But, that all said, we've made great progress. And when we're done with the liquidation portfolio we will have a substantially great progress on de-concentrating the portfolio.
So the percentage of our capital basis deployed to our top 20 corporate clients, the single-name concentrations, just the broader application of our tightened risk tolerance means that we should be moving down towards more acceptable levels of loan impairment independent of the environment. But, of course, we're still going to be challenged, as long as the environment is as it is.
Yes. And I think in the corporate space, clearly, just each quarter as we go by the focus upon returns is just increasing throughout the business; and the initiative to take out some of the lower returning RWAs for the client relationships has been progressing and is very much on track.
With Simon on board, his focus now, upon a point which Bill made, how can we broaden the range of clients that we service; how can we broaden the range of sectors that we service; how can we do that in a slightly less asset intensive way; how can we increase the velocity of throughput through the balance sheet, they are all the things that we are focusing upon, which is why you see what you're seeing there.
But there's nothing [indiscernible] in the model update?
Nothing significant, no.
Fahed Kunwar, Redburn. I just had a question, I guess, following on from the ROE and cost question. The operating leverage in the second quarter year on year was the jaws was minus 5%; I think, for the half was minus 10%. In what is going to be a subdued revenue environment probably for a little bit of time at least, what kind of jaws are realistic, considering you've got investment then coming in the second half of the year, and looking out, without that big boost in revenue growth? Thanks.
I don't think I would set out to manage a business purely on jaws. This is going to be about, separately, what can we do to get our share of income growth, particularly, if the macro environment is tougher? There is more work that we need to do there.
On the other hand, we have got a lot of opportunities. We know the business hasn't been firing on all the cylinders recently, and that is what we're now trying to do. Separately, saying to the business we must become more efficient, we must take out the duplications in efficiencies and must really get the cost side of it down. It's not, the only explicit one we have said in terms of a jaws or cost-related target has been on retail where we've said operating at 70% or so is just not where we need to be and the journey to get to 55% is very clearly established in the business it will take some time. But, in some senses actually, the thing that is impeding us slightly more is the income, not so much the cost side at the moment, but that's the one for the map. So we'll do what we can on the income line, on the cost line separately, rather than run it to a particular target on overall Group jaws.
And just one to follow up, on the revenue, is there are mark-to-market losses in the second quarter, or should those [indiscernible] out as we go forward?
We took some negatives on principal finance. There's about a negative 1.70 on income in the first half of principal finance which is mark-to-market related, so you can form a view as to whether that's recurring or whether that's not. Other than that, there wasn't anything particularly significant in there.
Thank you. Michael Helsby, BAML. I just want to have a quick follow up on the capital side, because I think you correctly identified that you had a buffer at the time of the rights issue for the regulatory uncertainty. And I was just wondering if you could remind us what that buffer in core Tier 1 points was and clearly, if we get clarity over the second half of the year then we've got a framework of how to think about you guys. Thank you.
Yes, I think, when we talked about this in November we put the various building blocks in there in terms of income costs, LIs et cetera; and then we had the other category which included regulatory and things like that. I think there was tacit acceptance that whilst we've got investigations going on in the U.S. it's not completely beyond the wit of man that there isn't some costs at any point in time on that and we had the whole Basel IV-type issue. Neither of those are as yet clear time will tell on both of them.
I don't think it's that we change our view; it's more back to the previous question that it's probably better just to run a little bit conservatively for a period of time and then we have got the ability to absorb, and we'll see where we go thereafter.
Yeah, I mean it's not specifically [indiscernible] in that way it's more generally there because there are things that could on balance be a challenge for us. So it's not got the precision that your question is looking for.
Thank you very much. It's Tom Rayner, Exane BNP Paribas. Can I just go back to the outlook statement, please? Because I had a little read of your statement at Q1 and it didn't seem, it seemed to be pretty much everything was going in line with expectations and you were fairly confident about investing for sustainably higher returns. There didn't seem to be any of the caution which has now appeared in the outlook statement today. I'm just wondering in the last three months why there's been such a change in tone and if, maybe you could explain exactly what is going to now delay the achievement of the ROE targets. Is it mainly a revenue issue that we're talking about here? Or is there anything on the regulatory side that maybe I'm missing?
We have a lot going on at the same time. We've got a very, very rich agenda of internally generated things, and a very complex agenda of externally generated things, and some of those things are interconnected.
When we reported our first-quarter earnings we were quite happy with the progress that we'd made on the things that we can control, and we'd had an external environment that was mixed. We had the uncertainty coming out of the second wave of volatility in China, and we had the client flows that came out of the second wave of uncertainty around China, which, on balance, we could say was neutral, but with good momentum in terms of the activities we were taking.
As we reflect now, six months in to this year, or seven months in to the year, and eight months since we made our strategy statement, you have to note that Q1 GDP numbers came in at about the half level that they were at last year in most of the markets in which we operate; some exceptions, India being the obvious one, China being another obvious one, but there's obviously a lot going on in that GDP figure. And global trade flows have continued to be suppressed, consistent with GDP growth. The forward market, for lack of a better proxy, for US dollar interest rates has moved down substantially during that period. And those are the things that are macroeconomic that drive our results.
When we look at what the market is saying, and our own view, we have to say that there's a level of caution that's appropriate now that has stepped up in the last three months. We call it a realization of some of the things that were happening in the first quarter, but were really only called after in the second quarter. I think that the outlook statements are probably consistent. And I think, at the end of the day, we're going to call it as we see it, and this is the way we see it right now.
There's clearly revenue pressure. And to the extent that we're still sitting on a risky portfolio, there's non-impairment possibilities. We think we've got, we think we're taking the actions that we need to take to mitigate to the great extent possible. But, obviously, if we have a long period of very low growth, other sectors that have held up so far will begin to buckle.
Chris Manners, Morgan Stanley. Two questions, if I may. Firstly, maybe geographically, on Hong Kong, I can see in the first half you've managed to grow loan balances by about 10%, from $55 million to $61 million. Maybe you could just give us a few thoughts on the operating environment there. Obviously, that loan growth, presumably, is, maybe there's something lumpy in there. Just a little bit on the outlook for the loan growth and margins for your Hong Kong business.
The second one was just, maybe, to come back to the restructuring charge again. I guess that you're saying that the operating environment has deteriorated since you came up with your $3 billion guidance. And just trying to understand, is there a chance of that $3 billion being upsized, or was it a conservatively struck when you put it together in the first place? Or just maybe a few more thoughts about how that portfolio's going. Thanks.
Yes, I think, on Hong Kong, it's clearly taken some of the impacts of what happened in China earlier in the year; and that has impacted the market fairly broadly. I think more recently, certainly, with our team, there's more confidence that things are actually now settling, and that, as we look forwards, we're on a more even keel as we go forwards, which I think is encouraging. But, clearly, it's an important market for us, and one which we keep a very close eye on.
The restructuring, listen, trying to work out 18 months ahead exactly what is the right number is never going to be a precise exercise. I think, as of today, as I said earlier, it's in the right zone. We're $2 billion through it. The loan portfolio, liquidation portfolio we're making progress on, but until we've actually closed things down then you don't know exactly where you end up. So I'd say, order of magnitude, I think we're heading in to the sort of space that we thought we were going to be in; it's not significantly better, it's not significantly worse.
Thanks. Just on the Hong Kong loan growth, 10% half on half, presumably, that's not a sustainable number. Just trying to work out is there anything, is that going to come back down again? Any thoughts around that would be really [indiscernible]
There's a lot going on in Hong Kong. There was the wealth effect in terms of volatility in markets that [indiscernible] itself in the first half; that's receding as people are getting back to a new normal. There's the onshoring of Chinese debt that had been offshore, so significant repatriation of Hong Kong-based liabilities in to the Mainland. We're obviously less competitive on the Mainland than we are in Hong Kong, so that resulted in a net reduction in our balances across the region. There was a significant pull back in terms of investment flow in the first half, which again manifests itself in our lending book, but also corporate finance activity. I would say that's stabilizing and the pipeline is more encouraging than the first half would suggest.
But there's also been a shift in our book. So a much bigger portion of shore-related unsecured and secured financing out of Hong Kong which is typically lower returning, but does obviously contribute to loan growth and it's broadly flat year on year.
Joe Dickerson with Jefferies. I just have a quick question. On slide 39, you break out the China exposures and they're up about $6 billion half on half or about 12%. I was just wondering, what drove the appetite to increase that portfolio? And what are the [indiscernible] aspects that were responsible for the growth?
It doesn't reflect a fundamental shift to risk appetite. These are, as you've seen also that the portion of the book that's under one year maturity has gone up during that period, so it's an increase in short-dated transaction-related exposure. Some of this offshore financing that shifted onshore, we did pick up some of that in China. We didn't pick up all of it, by any means. Our overall Greater China, North Africa and North Asia region has seen downward pressure in just about everything that we've done in the first half. But we've seen a recomposition of the Mainland Chinese exposure largely round financial institutions, largely short term and largely trade-related.
Chira from Bernstein. Quick question for three of you. Resumption of the dividend, what are the dependencies that you can see from here on to the end of the year before you get there?
Same as we've said before: we want to see, convince ourselves that we've got a sustainable income stream that can support a dividend and we want to be absolutely sure that we've got an appropriate overall capital position. We're obviously making progress on the income and profit side but we, at 2% ROE would all recognize we have some further convincing to do. And on the capital side, we discussed, with the uncertainties around the Basel IV process it just seems premature to declare ourselves in a great capital zone. But that should become clear over the second half of this year.
I think we're probably out of time and out of questions, unless we have anything else on line?
Good. One last question.
Claire Kane, Credit Suisse. Just one quick question, hopefully. On the $50 billion of optimization RWA, you mentioned that it's actually RWA that's outside that original portfolio that's adding pressure as you're not seeing the benefits of the optimization to date. Would you be able to give us an idea, if you were to recalibrate that $50 billion, how much bigger would it be today?
I can't give you a precise number, but it's, there's the constant flow. So we know the client relationships, in any case, are lumpy. A substantial fee-generating deal of one year may not be replicated the next, but we may have a high degree of confidence that it's coming in, in the years to come. But what we're seeing is, and you can see it in our income line, [indiscernible] revenues have been under pressure, for the very simple reason, it's not because we're losing share. We're not losing share. In fact, we've probably added share in trade, where we continue to be recognized as the leading trade Bank in Asia; we're probably adding share in corporate finance; and probably adding share in capital markets as well.
But the volumes are down dramatically. So, and that obviously flows through to the return on RWA for each of these client relationships. The fact that we've got clients that are dropping down in to the inadequate return zone doesn't mean that we've got clients that are, on an expected value basis, no longer positive. Some have dropped down. Some have migrated from a credit perspective. So nothing's changed, other than the RWAs have gone up; and those we have, we have to work harder. We've got to generate the incremental return, or we'll have to part ways with those clients over a period of time. But in this environment, to have a dip down in terms of returns in a half-year period, it's not surprising. It's not particularly concerning. But it does mean we've got a bigger hill to climb, which we all recognize, and Simon and then team are completely focused on that.
Good. Thank you very much for the time; I know it has been an extraordinarily long morning. So, thanks, again. And we look forward to seeing you soon.
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