RBS Not Worth £4 a Share

Morningstar analysts have downgraded their fair value estimate for Royal Bank of Scotland as it sells off risky assets in a bid to clean up its balance sheet

Erin Davis 17 December, 2013 | 1:32PM
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While the worst is past Royal Bank of Scotland (RBS), its internal bad bank will have about £46 billion of noncore assets that it plans to run-off on an accelerated schedule, which poses significant risks for the bank.

Losses could be higher than expected, and divestitures may not bring the prices RBS is anticipating. While RBS has relatively little exposure to Greece - less than £1 billion - the group has about £35 billion of exposure to Ireland through its Ulster subsidiary. If real estate losses increase in Ireland, losses there could consume a large chunk of RBS' equity and possibly force yet another capital raise.

Shareholders also face the likelihood that the Government will direct RBS' lending with political, rather than business motives, as we have already seen with RBS' decision to increase lending to small and medium sized enterprises (SME). Decisions like these will likely mean lower returns for shareholders, and may involve higher losses over time if RBS is pushed into excessively risky lending.

We think that Government policy plays a significant role in RBS' governance and capital allocation decisions. In particular, we were distressed by the public outcry that forced then CEO Stephen Hester to waive his very modest £1 million bonus for 2011, after which he reportedly considered resigning. Eventually, in 2013, he was forced to resign, which was to shareholders' detriment, in our opinion, as he had been doing a good job righting the sinking ship.

We've seen many more signs of government interference in business decisions, from putting pressure on RBS to increase SME lending, threatening to break up the bank, and forcing the bank to accelerate run-off of its bad bank.

While RBS' precrisis management destroyed a crushing amount of shareholder value, we think its new managers have been standard stewards of capital. Ross McEwan, the bank's second post-crisis CEO, took over as CEO in August 2013 We're glad to see RBS becoming a smaller, more focused institution, and we think that McEwan's appointment signals a commitment to that strategy, as he was previously head of the bank's U.K. retail operations.

We're reducing our fair value estimate for RBS by 15p to £3.85 a share as we incorporate the losses caused by the accelerated rundown into our fair value estimate. We assume that total assets fall 2.4% in 2014 after shrinking nearly 10% in 2013, and that they grow an average of 2.3% between 2015 and 2017.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
NatWest Group PLC375.30 GBX2.07Rating

About Author

Erin Davis  is a senior banking analyst for Morningstar.

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