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RBS: a new era of certainty?

The state-backed banking group has reached settlement with the US Department of Justice
May 11, 2018

Royal Bank of Scotland (RBS) chief executive Ross McEwan is right to call its settlement with the US Department of Justice “a milestone moment”. The state-backed banking group’s $4.9bn (£3.6bn) civil settlement with Federal authorities over historic mis-selling of residential mortgage-backed securities is much less than the market had expected. Crucially, it paves the way for the recommencement of dividends and the government sale of its 71 per cent stake.

IC TIP: Hold at 295p

Most of the sum has already been provisioned for – $3.46bn – with the remainder to be taken as an incremental charge during the second quarter of this year. Together with the £2bn pension contribution, that will result in a 50-basis point reduction in its common equity tier one ratio to 15.1 per cent – still comfortably ahead of its near-term 14 per cent target – and a 9p decline in its net tangible asset value, to 274p at the end of March.

Mr McEwan said the group would be immediately starting the conversation with the Prudential Regulatory Authority on what information it needed to submit to gain the green light to re-start dividend payments. Ultimately, that approval will hinge on the outcome of the Bank of England annual stress tests, due to be published in December.

Those tests apply an adverse theoretical scenario to the balance sheets of the UK’s seven systemically important banks. RBS failed last year’s test, falling short of the hurdle rate for CET1 capital – even after including debt that could be converted into equity. As part of their submissions, banks must provide stressed projections on all potential costs related to misconduct risks, which will typically be higher than any provisions already made. In that respect, the much lower settlement than anticipated, puts RBS is in a better position entering this year’s test. Bloomberg analysts are forecasting a consensus 6.4p dividend per share this year.     

RBS had made strides in improving its balance sheet. Last year it wound up ‘bad bank’ Capital Resolution, by which time it had reduced its risk-weighted assets by two-thirds in the nine years since its 2008 government bailout. The cost-to-income ratio also reduced to a respectable 79 per cent last year, down on 129 per cent in 2016. Consensus return on equity expectations are running at their highest level in a decade, at 7.7 per cent this year, according to Bloomberg.  

However, challenges remain. Further costs associated with mis-selling of payment protection insurance are expected before next year’s August deadline. What’s more, generating income at a decent margin in such a feeble interest rate environment is a tough task, particularly for lenders that have switched to more vanilla retail banking. That’s exacerbated by a highly competitive mortgage market – RBS partly blamed this for a tightening in the net interest margin at its core personal and business banking division during the first quarter.