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Royal Bank of Scotland Group plc (RBS) Ord GBP1

Sell: 346.50pBuy: 346.60p012.80p (3.56%)
FTSE 1000.76%
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HL comment (30 April 2015)

Huge charges relating to past misconduct and the restructuring of the business continue to push the bank into the red, but underlying improvements in profitability are clear. But RBS is struggling to achieve income growth and the shares have been marked down around 2% in early trade. RBS has reported underlying operating profit of £1.6bn, up 16% from Q1 2014. At the reported level, the bank produced a loss of £446m due to restructuring costs of £453m and £856m of litigation and conduct charges.

Core UK franchises saw volumes rising and operating profits improved in Private & Business Banking (PBB) and Commercial and Private Banking (CPB) compared to Q4 2014. Corporate and Institutional Banking is said to have made a good start on the radical restructuring plan it announced in February. RBS's overall performance is benefiting from generally benign credit conditions that have allowed £91m of net provision releases in the quarter.

Key Statistics:
  • Common Equity Tier 1 ratio of 11.5%, up 30bp from the year end level.
  • Risk Weighted Assets (RWAs) down 2% to £349bn, scheduled to be sub £300bn by Dec 31.
  • $3.7bn raised from sale of shares in its US banking business, Citizens in Q1, further $250m raised in April. RBS stake now 40.8%.
  • RBS to cut costs by £800m in 2015, even after the increased UK Bank Levy.
  • Tangible net asset value per share of 384p, vs. 387p a year ago.

Total income was £4,331bn, up 12% from Q4 2014, but down 14% on Q1 2014, reflecting the shrinking of the Corporate & Institutional Banking division. Adjusted operating expenses were £2,788m, down 11%, reflecting headcount reductions.

Loans and advances to customers were £333bn, with reductions in the RBS Capital Resolution disposal portfolios offsetting growth in the core businesses.

Divisional Performances:
UK Personal & Business Banking - Adjusted operating profit rose by £232m to £732m. Total income fell £11m, reflecting lower personal loan balances. Mortgage lending increased by £3.7bn and net loans and advances to customers rose to £127.4bn. Ulster Bank's results were impacted by lower provision releases and a weak Euro, but it remained profitable.

Commercial Banking - Operating profits of £412m were well up on the £321m in Q1 2014, reflecting an absence of prior conduct and litigation charges in the division. Operating expenses were flat, reflecting headcount reductions, whilst benign credit conditions saw net impairments of just £1m. Commercial banking grew lending by £1.3bn.

Corporate & Institutional Banking -
The division commenced its radical restructuring plan, and most customers have now been informed of how they will be affected. Adjusted operating profits were £50m compared to £372m in Q1 2014. Income declined by £547m to £804m as RBS withdrew resources from the business, notably the Credit desks. Adjusted expenses were 18% lower and RWAs dropped by £37m.

RBS Capital Resolution -
The "bad bank" reduced its funded assets by 25% in the quarter, to £11bn, reflecting the sale of loan portfolios and repayments. 

Looking forwards:
RBS said that the outlook was unchanged from that given at the full year results, when they said they expected the core divisions to perform well, but with a significant fall in income at the Corporate and Institutional Banking division as that was restructured.

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Our view:
RBS is still very much en route, with a fair way still to travel. But progress is pretty clear. The improvement in operating profits was immense, partly a function of one-offs dropping out of the equation, but still substantial at the underlying level. Costs are way too high, but under attack. They have to be though, because with RBS aiming to lose a further £60bn or so of Risk Weighted Assets, approaching 20% of the group total, income will still be under pressure for a while longer.
 
But the core of RBS is starting to look quite shiny. The PBB division is generating a great Return on Equity and CPB is catching up from behind. Both are generating returns far ahead of HSBC for instance. That's a slightly unfair comparison, because PBB and CPB have had the bad stuff extracted from them, whereas HSBC's single digit ROE is a warts and all number.

When the group gets up to a 13% CET1 ratio, it intends to resume dividend payments. We'd expect these to be modest at first, but conceivably, a 2015 final payment could be possible. The hit from writing off Citizens goodwill has already been taken, so the swing factor on capital generation is now regulatory costs. Reports of another £10bn of fines and redress costs have been coming across the newswires in recent weeks. That scale of retribution could delay the dividend restart, but it will not threaten the viability of the bank.
The stock is trading a little above tangible book value, but still making a sub-standard return overall. As the contribution from the core divisions becomes less and less clouded by restructuring costs and write-offs, and as the CIB and RCR divisions are brought to their intended long term shape, we would expect RBS shares to move to a premium to their Tangible NAV, assuming those core PBB and CPB divisions continue to earn high returns. But we are some way off that position. For now, RBS shares remain firmly in the territory of the patient and the brave.

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