As expected, 
Royal Bank of Scotland (RBS) reported a huge loss and poor underlying performance for 2013. The bank reported a net loss of £9 billion, which included £10.4 billion of regulatory, legal, restructuring, and impairment charges. The loss was the bank's second largest since the financial crisis and brings cumulative losses to nearly £49 billion.
Underneath these huge losses was the subpar performance of RBS' core operations; underlying return on tangible equity was just 2.5%. We were shocked by management's description of the complexity remaining in RBS' operations after six years of restructuring—RBS currently has 247 ongoing restructuring projects, 109 different credit card options, and processes 7.8 million payments manually each year - and the additional clean-up costs will be larger than we had anticipated.
Still, our long-term expectation that the bank will earn a return on tangible equity of about 10% remains intact, and we plan to reduce our fair estimate for the no-moat bank only modestly. RBS sketched out its restructuring plans, and we generally like what we see. The bank will divide its operations into thee businesses (down from seven) – personal and business banking, commercial and private banking, and corporate and institutional banking – each of which will consume roughly one third of risk-weighted assets. It plans to focus much more attention on customer service, an area that we think has been too long neglected as RBS fought one fire after another.
We think RBS' success here will be an important driver of the group's long-term value; its personal and business banking segment is both the bank's most profitable and its most vulnerable to poor customer service, especially as new laws and technology make it easier for U.K. customers to move their bank accounts. RBS plans to restate its financials and formally move to its new business structure in the second quarter.
The best news in RBS' report was its capital, which although still subpar was better than expected. RBS' fully loaded Basel III ratio was 8.6% for the quarter, comfortably above the 8.1% it guided as a minimum for the quarter. RBS said it plans to increase this ratio to 11% by year-end 2015, which implies adding the equivalent of £10 billion of capital through retained earnings or RWA education; we project that the bank can do it, but just barely. Another material "unusual" charge could set back RBS' capital plans – and if RBS makes it through 2014 without a substantial unusual charge, it would be doing so for the first time since 2007.
Still, we don't expect dilution through an equity raise, as the U.K. government has no desire to pour more capital into RBS. Instead, we think yet another setback would mean further delays in returning capital to shareholders. We're currently pencilling in nominal dividends for 2016.
