Royal Bank of Scotland Ordinary 25p (RBS)

Company overview

Royal Bank of Scotland PLC is a major provider of banking and insurance products, along with a selection of other financial services. While headquartered in the UK, it has a substantial business in the USA and is further represented across large parts of continental Europe. Its brand names include NatWest Bank, Mint Credit Card, Ulster Bank, Coutts private bank, Direct Line and Churchill insurance, Green Flag, along with Citizens Bank and Charter One Financial in the USA and ABN Amro.

HL Comment (4 November 2011)

The bank's third quarter update (04Nov2011) saw management reporting some headway amidst turbulent conditions. Like rival Barclays, an accounting adjustment in relation to the group's own debt helped the company report a profit. Attributable profit of £1.23 billion was reported for the quarter, up from a loss of £1.15 billion seen in Q3 2010. However, fortunes across the group remained mixed. Overall group income for the period declined by 18% to £6.35 billion compared to the second quarter, with the decline in revenues at the group’s investment banking division impacting (-29% to £1.1 billion). In contrast, and aided by reduced bad debt provisions, the bank’s Retail & Commercial business maintained income during the quarter, with year-to-date profits up 9%. Accompanying management comments noted that "the results showed the improved strength and resilience which the bank had built up since 2008. They also highlight the external pressures facing banks, and economies more broadly, pressures which are making the road to recovery longer and bumpier than hoped for".

Negative Points:

• Operating profit, when excluding accounting gains from debt valuation adjustments, declined by 63% to £267m when compared to Q3 2010. The ongoing shadow cast by the crisis in Europe impacted trading at the group’s investment banking division in particular.
• Although now reduced, RBS continues to hold investments in European Government Bonds, including Greece and Italy. Given ongoing difficulties in Europe, management highlighted its expectation for tough fourth quarter market conditions.
• Changes suggested by the Vickers Banking Report, a UK Government commissioned review, if implemented, are expected to increase costs going forward.
• As a result of the Government's bailout, RBS has been ordered by European regulators to dispose of a range of assets by 2013, including its insurance division. Leading UK market positions are being reduced via the imposed sales.
• Following a series of UK Government banking bailouts, including RBS, a new tax was introduced. The 'bank levy' is expected to cost the RBS £225m to £250m in 2011, rising to approximately £350m to £400m during 2012.
• The bank is still prohibited from paying a dividend.
• Being part nationalised appears to place the group at a disadvantage to its competitors without Government interest – lending and staff pay policies have been influenced.
• The government's shareholding raises long term questions – when and how will the government reduce/sell its holding?
• The bank's recovery remains dependent on a sustained economic recovery, particularly in the UK and Ireland, although also for the USA and Europe.

Positive Points:

• Bad debt provisions declined to £1.54 billion during the quarter, down by £728 million when compared to Q2 2011, principally driven by lower provisions with regards to Irish development land values. Trends in most divisions remain broadly stable and comparable with the previous quarter.
• A strong focus on costs continues to be made. Group third quarter operating expenses came in at £3.82 billion, down 2% from the second quarter and down 6% year to date.
• The group's capital cushion continues to be improved - core tier 1 ratio improved further to 11.3%, from 10.7% as of the end of 2010.
• The British Bankers Association has previously noted that RBS was on target to meet its business lending commitments drawn up under the “Project Merlin” agreement with the Government. The board previously noted that it had provided a total of £44.2 billion of new lending to UK business customers during the first half of the year.
• Management is aiming to achieve a double-A credit rating by 2013.

Consensus

On balance, market consensus indicates a strong hold.

All yield figures are variable and not guaranteed.

Fundamental Data

Values are quoted in the stock's local currency: British pound.

Year Ending	Revenue (m)	Profit Before Tax (m)	EPS (p)	P/E Ratio	PEG	EPS Growth (%)	Total Dividend	Dividend Yield
31-12-2010	31,868.00	(399.00)	(0.50)	65.10	n/a	n/a	n/a	n/a
31-12-2009	33,026.00	(2,647.00)	(6.30)	n/a	n/a	n/a	n/a	n/a
31-12-2008	25,868.00	(40,836.00)	(146.20)	n/a	n/a	n/a	n/a	n/a
31-12-2007	30,366.00	9,832.00	79.50	3.80	n/a	(50.00)	33.20	8.90
31-12-2006	28,002.00	9,186.00	194.70	2.90	0.20	15.00	90.60	16.30