Morningstar analysts said the £2.7 billion loss reported by the Royal Bank of Scotland (RBS) last week was in line with expectations. However they warn that 2016 will continue to be “another ugly year” with heavy litigation and restructuring costs continuing.
However, it is not all bad news. Although in the short term the outlook is fairly bleak, Morningstar remains confident that RBS is on the road to recovery: “Our thesis that it is a diamond in the rough--a bank on its way to becoming a profitable one with significant excess capital--remains intact.”
Analysts concede though that this transition to profitability won’t be smooth. It said the drop in share price, following Friday's “messy” fourth quarter results was because the market was disappointed that capital return won’t begin until late 2017 or 2018. Morningstar says though: “We’re less surprised--we had expected this to be a long and bumpy road.
“But we were disappointed by the underlying performance of its business divisions and management’s indications that the separation of Williams & Glyn will be slower and more complex than had been expected.”
There are also questions around the varied payments it needs to make over the next few years. “RBS intends to pay its last dividend on the state-held Dividend Access Share, and we think the $1.2 billion payment will be enough to tip the bank into a loss.
“We also expect heavy provisions for litigation. The bank now has £5.6 billion of provisions for civil litigation settlements, the most important of which is likely to be the settlement with the U.S. Federal Housing Finance Administration, which we’ve estimated at $3.9 billion (£2.8 billion).
“We’re projecting that 2015-17 litigation costs will total £7.3 billion, £3.6 billion of which was incurred in 2015. RBS has not yet provisioned for settlements with the U.S. Department of Justice or the U.S. states’ attorneys general. We expect that a settlement with the DOJ will cost the bank about $3 billion (£2.1 billion) and that settlements with the states plus additional civil litigation costs will add another £1.6 billion.
Morningstar said there was good and bad news in RBS’ operating results. On the more positive front, full-year adjusted return on equity was solid at 11%, fourth-quarter loan growth was over 10% annualized in RBS’ key U.K. retail and commercial banking segments, and credit quality continued to improve.
Capital was another bright spot: The bank reported a 15.5% common equity Tier 1 ratio, in line with our projections and well ahead of its 13% target.
The bad news centred on revenue growth. RBS saw both fee income and net interest income fall in U.K. Personal and Business Banking, as net interest margin fell 11 basis points sequentially, to 2.9%. This is in sharp contrast to results one of its main rivals Lloyds Bank (LLOY), which saw its net interest margin continue to climb on lower funding costs. RBS also reported a sharp drop in revenues in the more volatile Corporate & Institutional Banking, which reported a full-year loss of £837 million despite continued cuts in operating costs.
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