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Royal Bank of Scotland - Litigation costs continue to hurt

Nicholas Hyett | 5 August 2016 | A A A
Royal Bank of Scotland - Litigation costs continue to hurt

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RBS reported an operating loss before tax of £274m (H115: 261m profit) for the first half, with losses in the second quarter of £695m (Q215: £224m profit). Attributable losses rose to £2bn following the payment of the government's £1.2bn dividend access share. RBS shares fell more than 5% in morning trading.

Adjusted operating profit across the group's core Personal & Business Banking (PBB), Commercial & Private Banking (CPB) and Corporate & Institutional Banking (CIB) divisions was down 15% in the half, versus £2bn in H115, with adjusted Q2 profits down 14% at £1bn. Adjusted return on equity in these divisions was 11%, with net lending growing 15% on an annualised basis.

Losses in the Capital Resolution bad bank increased to just over £1bn, contributing to a worse adjusted cost:income ratio of 72%. (H115: 64%). Risk weighted assets (RWAs) within Capital Resolution fell £26.3bn versus H115, to £42.3bn. Litigation and conduct costs added up to £1.3bn, including provisions for PPI misselling as well as other UK litigation costs.

The Group net interest margin increased by 4 basis points to 2.18%, benefitting from a reduction in low yielding assets which more than offset margin pressure and mix impacts in PBB and CPB. Operating expenses in the second quarter were £196m lower than Q215.

The Common Equity Tier 1 Capital Ratio (CET1) is lower than at FY15 at 14.5%, but still comfortably ahead of the group's 13% target.

Outlook:

Following the announcement in April that the Separation of William's and Glyn may take until the end of 2017, RBS is exploring options for selling the division. Discussions are continuing. Uncertainty continues to surround the results of US RMBS litigation - which may require substantial incremental provisions.

Following the vote to leave the EU and lower interest rates, achieving cost:income and return targets by 2019 is expected to become more challenging. Income across the core divisions is expected to remain flat on 2015, as increased lending offsets headwinds from lower interest rates and macroeconomic uncertainties. RBS continues to expect to deliver cost reductions of £800m in 2016.

Our view:

It might not look like it on the surface, but RBS' core divisions have put in an OK performance. Adjusted operating profits, i.e. after all the bad bits, were up 2% on the previous quarter, with the all-important lending figures up substantially across PBB (up 12%) and Commercial Banking (up 8%).

Unfortunately, those bad bits just keep on coming at RBS. Other banks have been putting conduct costs behind them but RBS has announced another £1.3bn today, including £450m of PPI charges. Nor is this the end of the saga. Investigations into misselling of US residential mortgage backed securities (US RMBS) is likely to result in further large fines.

The bad bank continues to haemorrhage money, as expected, and that is likely to continue next year. The only saving grace here is that the wind down continues apace, which is more than can be said for Williams & Glyn.

RBS must split W& G out as part of the settlement made with the EU for receiving State Aid when RBS was rescued. It was originally mandated to happen by the end of next year at the latest, but the expected date was pushed back to 2018 in April. Today the bank has suggested a change of tack as it looks to sell the bulk of the business. There's still no news of firm progress though.

Beyond the less than exceptional exceptionals, RBS' core business is expected to be broadly stable for the rest of the year; the balance sheet growing as lending activity increases. The bank is on track to cut £800m of costs this year, having taken £196m off the cost base in Q2, while record low interest rates means bad debts should be low.

Overall though, with litigation costs continuing to hang over the future, a less than rosy outlook for the core UK business following the referendum, and uncertainty remaining around W& G, RBS still looks some way from rude health.

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