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Carson Block: Why We Are Betting Against StanChart

Monday, 13 May 2013 | 1:41 AM ET
David Paul Morris | Bloomberg | Getty Images

Standard Chartered's asset quality is deteriorating and investors are miscalculating risk in the loan book of the British lender, according to Carson Block, founder of U.S.-based short seller Muddy Waters Research.

Block told CNBC his firm is buying 5-year credit default swaps for the bank, a trade that would profit from a default.

"The market, we believe, is under estimating the amount of risk in the loan book. (And) the thing to realize with Stan [Standard Chartered] is we don't believe it's systemically important in any jurisdiction that can afford to bail it out," Block said on Monday.

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He argues that while the bank's business is well diversified across many markets, its sizable exposure to emerging markets could be detrimental if growth in China, the world's second largest economy, continues to slow.

"The vast majority of emerging markets are really tied to China. The correlation in Standard Chartered's loan books gets very high, that's the problem that investors really need to think about," he said.

Standard Chartered, which does not formally report quarterly numbers, said last week that first quarter saw a "slight" decline in profit and warned that it could miss this year's revenue target after higher bad debts and falling interest rates hit earnings.

(Read More: Standard Chartered Hit by Profit Fall, Shareholder Protest)

There are already signs of "deteriorating" metrics in the bank's loan book, Block said, including a rise in loans that were 60 days past due in its wholesale book last year and "aggressive" growth in loans to mining companies last year.

While Standard Chartered has set aside $3.1 billion, or 1 percent of its loan book, as a provision for bad loans, Block counters that this is insufficient given the lender's robust loan growth in the recent years.

Since 2002, the bank's loan book has grown around five times from $60 billion to approximately $300 billion, while provisions have just risen from $2.1 billion to $3.1 billion over the same period, according to Muddy Waters.

"The provision is only 50 percent greater. That's one reason we feel the market is underestimating the credit risk," he said.

(Read More: China Firms Can Follow Rules: Muddy Waters Target)

Block said the 5-year credit default swaps for the bank which Muddy Waters is buying cost 85 basis points over U.S. Treasurys. Credit default swaps are used to buy protection against the likelihood of a borrower defaulting on its debt as well as a means of speculation.

"This is cheaper than all those too-big-to-fail institutions," Block said at the SALT hedge-fund conference held in Las Vegas last week, referring to lenders such as Citi and Bank of America.

Standard Chartered declined to comment when contacted by CNBC.

By CNBC's Ansuya Harjani

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