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Standard Chartered PLC’s Business Model “Isn’t Sustainable”

Standard Chartered’s (LSE: STAN) is one of London’s fallen angels. Indeed, Standard used to be one London’s most successful banking groups but the group’s outlook has been deteriorating for some time.

Things have now become so bad for Standard that City analysts are starting to question the group’s long-term outlook. One set of City analysts has gone so far as to say that they don’t believe Standard is sustainable as a business in its current state. 

Not sustainable

Analysts are concerned about Standard’s falling return on equity, a key measure of banking profitability. In the simplest possible terms, return on equity means the amount of net income returned as a percentage of shareholders equity. And this figure should be above the cost of capital — the cost of funds used for financing a business. 

If Standard’s return on equity stays below 15% for much longer, the bank’s income won’t cover the cost of capital required to run the business. The bank is targeting at return on equity of 10% in the medium term, which is clearly not enough. 

Recapitalise

The only way out of this tangle is for Standard to raise cash, reorganise its loan book and look for opportunities to expand its balance sheet. If management make these changes, the group should be able to improve its return on equity and return to growth. 

On that basis, City analysts believe that Standard’s new management will conduct a rights issue in order to raise around $5.3bn. This should be enough to recapitalise the bank and help return Standard to growth. 

With a market capitalisation of £24.2bn, the bank is well placed to conduct a small rights issue and raise the $5.3bn analysts believe will be enough to recapitalise the group’s balance sheet. 

Of course, Standard could always go for broke and conduct a huge $10bn+ rights issue to allay all fears about the bank’s capital levels and growth rate once and for all.

While this would be damaging to Standard’s share price in the short term, the bank’s long-term prospects would improve significantly. A strong balance sheet and restructured loan book would give Standard the perfect foundations to drive growth.

Dividend cut

Unfortunately, if Standard dose conduct a rights issue, the bank could also be forced to cut its dividend payout. This would be bad news for income seekers. Standard’s shares currently offer a dividend yield of 5.9%, one of the highest yields around.

So if you brought Standard for income, now might be the time to sell up and look for other income opportunities elsewhere.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.