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Royal Bank of Scotland - Dividends Delayed

Steve Clayton | 26 February 2016 | A A A
Royal Bank of Scotland - Dividends Delayed

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NatWest Group plc Ord GBP1

Sell: 198.65 | Buy: 198.80 | Change 5.30 (2.73%)
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Royal Bank of Scotland does not now expect to pay a dividend for FY 2016. In 2015 the bank generated a loss of £2.0bn, but as is customary for RBS, that figure is heavily influenced by charges relating to the problems of the past. Adjusted operating profit for the year, which gives a better guide to underlying performance, was £4.4bn, compared to £6.1bn in 2014. The reduction is explained largely by losses on the disposal of assets from the "Bad Bank" and what RBS quaintly describe as "income attrition".

The shares dropped like a stone on the news, opening 10% lower.

UK Personal and Business Banking reported a stable adjusted operating profit of £2.2bn, with good mortgage growth and a 3% decline in costs.

Commercial Banking adjusted operating profit was down 6% to £1.4bn, reflecting some margin pressure and a 1% increase in interest income.

Ulster Bank adjusted operating profit fell 45%, to £264m, reflecting lower write-backs of previous provisions. Private Banking profit fell 41% to £113m and RBS International dropped 14% to £211m.

Corporate and Institutional Banking lost £55m, versus a prior year profit of £233m, because income fell faster than costs, themselves down 15% as the P45s fluttered around the City, due to the reduced scale of the business.

Capital Resolution, the "Bad Bank" lost £0.4bn compared with a profit of £1.1bn in 2014 as the unit accelerated the run-down of its portfolio, shrinking Risk Weighted Assets (RWAs) in half to £49bn, but incurring losses as it disposed of less and less palatable exposures.

Adjusted bank return on equity was 11.0% verses negative 1.5% in 2014. What RBS call Franchise ROE, i.e. excluding the Bad Bank, was 11.2%. The Common Equity Tier One ratio rose 430bp to 15.5% as RWAs fell by £113bn. Tangible net assets fell to 352p (2014: 374p).

In Q4, RBS made an adjusted operating profit of £686m, but the usual slew of charges for fines, compensation, provisions for more of the same and an accelerated staff pension fund contribution led to a reported attributable loss of £2.7bn, (2014: loss of £5.8bn).

During the year, RBS sold its stake in Citizens and achieved £1bn of cost savings. Restructuring costs of £2.9bn were incurred in the process. The scaling back of investment banking activities continued and whilst disposal losses on exiting non-core assets were incurred, the level of bad debt in the ongoing business was sharply lower, with £12.2bn of loans considered at risk, compared to £28.2bn in 2014 and £39.4bn in 2013.

Government Shareholding and Shareholder Dividends

The Government holds a special Dividend Access Share, which, as part of the bail-out conditions, must be paid £1.5bn before dividends can resume for ordinary shares. This requirement will be fulfilled during H1 2016. However, the separation of Williams and Glyn, mandated as a penalty for receiving State Aid, is proving drawn out, and the settlement of US mortgage securities regulatory claims is dragging on. RBS say it is now more likely that dividends will resume later than Q1 2017, which would appear to rule out a final dividend for FY2016 being declared.

Outlook

RBS say the Personal and Commercial banking divisions have had a steady start to the year, but the Investment Bank (CIB) has had a tough time of it. Cost savings of £800m are planned and impairments are expected to remain modest. Restructuring costs of over £1bn are expected and disposal losses of up to £1.1bn will be incurred.

Our view:

RBS is like an upside-down swan; all you can see are the ugly bits, paddling furiously at the air, whilst the glossy white plumage is deeply submerged. Personal & Business Banking and Commercial Banking are both performing perfectly well. The investment bank, is shrinking fast, but lobbing out grenades as it does so, while the Capital Resolution portfolio has only so much potential for bad news left within it.

But RBS is still dogged by litigation, with US mortgage securities likely to generate further large settlement costs. Disposing of Williams & Glyn is taking a while. Until these issues are dealt with, shareholders have to wait for their dividends to resume. The US settlement is outside of RBS' control, as to timing and scale, but it would seem rash to expect it to be either soon, or small.

Return on equity in the ongoing bank is already in double digits and ought to rise over time, as the investment bank is brought toward its finished, steady state and cost cuts stack up. But patience is required.

For investors, RBS should be alright in the end, for the retail and commercial banks are high quality businesses with strong franchises and good cash generation potential, much like Lloyds. Unlike Lloyds however, there is no prospect of a near term dividend income and every risk of capital outflows as the fines and disposal losses rack up. Restructuring charges will go on for longer too.

RBS trades far below tangible book value, reflecting the current uncertainties. Once the troubled assets are finally shed and the regulators pacified, the ongoing bank is likely to be valued at or above book value, as Lloyds is. The question is, can RBS retain enough profit as it goes through the process, to ensure that when it gets there, the tangible book value is still at or above the current share price of 225p?

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.