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Royal Bank of Scotland Group plc (RBS) Ord GBP1

Sell: 330.80pBuy: 331.20p00.50p (0.15%)
FTSE 1000.61%
Market closedPrices as at close on 8 October 2015Prices delayed by at least 15 minutes | Switch to live prices |
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HL comment (4 August 2015)

Update - 4 August 2015:
The government has started reducing its stake in Royal Bank of Scotland by selling 630m shares to institutions. Our thoughts on what this means to investors are:

The government still owns around 73% of RBS, even after the placing. The market knows these shares are headed its way, so will it give the stock a wide berth in the meantime, in the hope of forcing the government to sell cheaply?

The answer is likely to be both yes, and no. Stock overhangs like this can and do influence market prices from time to time, with buyers waiting until they think a bargain is on offer. But in my experience, these events are short-lived. The fundamentals will win out in the long run. If a business is growing well, or recovering from a difficult episode, then its progress will eventually find its way into the share price.

The government still owns too much of RBS to sell it all in one go. So expect to see more selling to institutions. I think a retail offer of shares is coming, but not for some time and only once RBS has settled its conduct issues and dividends are on the horizon. In the meantime, the evidence from recent quarters is that the underlying health of RBS is improving steadily.

We will continue to monitor the situation. Anyone interested in participating if the government sells its stake to the general public can register for our free RBS privatisation alerts.

Q2 Results - Released 30 July 2015:
RBS has announced Q2 results, accompanied by a statement that it will not return to paying dividends or making any other capital returns to shareholders before Q1 2017. Adjusted operating profits rose 11% from Q1 2015, but were down 7% on the year-ago level. Adjusted return on equity in what RBS is now calling the go-forward bank, was 14%, whilst the Exit Bank, containing all the bits RBS wants to sell or wind down, has reduced its risk-weighted assets (RWAs) by £24bn to £148bn so far this year.

RBS shares responded positively, rising by over 3% in response to the underlying progress at the group.

Our view:
RBS is like an upside-down swan. All you can see are the ugly bits paddling furiously in the air, whilst the swan itself glides serenely beneath the surface. The Go-Forward bank, which is centred upon the core NatWest and RBS retail and commercial banking operations, is performing increasingly well.

The Exit Bank is looking closer to actually being exited, with Citizens set to leave the group altogether later this year, and the Capital Resolution to run down by year end.

Conduct costs, aka whopping fines, continue to dog RBS and clearly, they expect a few to turn up in the next few quarters. Once they are out of the way though, and the Exit bank and CIB division are much reduced in scale, there will be less to detract from the underlying performance of the Go-Forward bank.

That looks better and better, with returns edging into the mid-teens. Cash generation is still poor, because of restructuring costs and conduct charges. But as those processes come to an end, RBS will be benefiting from a lower cost base, without those exceptional drains on cash flow.

At that point, it really ought to be a relatively simple, consumer and business-oriented bank, earning relatively stable returns and in time, capable of paying strong dividends. Legacy issues mean these are pushed back to no earlier than early 2017, suggesting a final payment for FY2016 will be the maiden payment from New RBS.

In the longer term, if RBS can maintain a return on equity in the mid-teens, then we would expect its shares to be rated accordingly. At the moment, the stock trades below its 380p tangible NAV (tNAV). That might see some further reductions as fines and exit costs chip away, but should resume growth once those fade away. The enticing question is, of course, what dividend yield, might a well-capitalised bank stock, valued below tNAV, but generating double-digit returns on that equity, be capable of offering?

  • The reduction in operating profit was caused by the well-flagged reduction in income within the Investment Bank, which RBS calls the Corporate and Institutional Banking division (CIB).
  • The stake in Citizens has now been reduced to just over 20%, with full exit expected by year end.
  • Conduct charges actually fell. In Q2 "just" £459m was charged, compared to £856m in the previous quarter.
  • Restructuring charges did the opposite, rising from £4553m in Q1 to £1,050m in Q2. Annulaised cost savings of over £700m were achieved in H1.
  • Adjusted operating profit, (which excludes Conduct and Restructuring) charges, rose 11% to £1.8bn.
  • RBS Capital Resolution continues to rundown, reducing funded assets by 44% in H1 and is expected to be completely rundown by year end.
  • RWAs declined to £326bn from £356bn at year end. When Citizens is fully deconsolidated, a further £70m of RWAs will be removed.
  • Capital is building, with an extra 80bp of Core Equity Tier 1 capital generated during the quarter, taking the Group ratio to 12.3%
  • Tangible net asset value was 380p, down slightly in the quarter, reflecting the impact of restructuring and conduct charges on reserves.

Key Issues:
RBS is increasing access to mortgages, with a 28% increase in mortgage advisers compared to last year and a 43% increase in new gross mortgage lending (i.e. before allowing for mortgage redemptions by customers). Their share of net new lending was 9.7%, ahead of their underlying share of existing residential mortgages of 8.3%.

RBS stress that they remain subject to ongoing Conduct investigations and actions, notably in relation to US mortgage-backed securities, FX trading and the treatment of UK SME customers.

The bank plans to return excess capital to shareholders via dividends or buybacks. But, this is secondary to strategic objectives being met, including sustained profitability, higher stress test scores and resolving those major conduct issues. As a result RBS does not expect to be in a position to return capital or pay dividends before Q1 2017 at the earliest.

Income in H2 will be held back by the ongoing rundown in the investment banking division. Chairman Philip Hampton makes the point that the cost of resolving conduct issues has greatly exceeded expectations and remains ongoing. He went on to say: "Looking forward, however, making customer service, trust and advocacy the focus of our strategy is starting to deliver results and by the end of this year I am confident that shareholders will see a clearer picture of the bank that RBS will become. This is an appropriate backdrop to the sale of shares by the UK government, which will be a significant moment for this bank".

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