We're increasing our fair value estimate for Royal Bank of Scotland (RBS) to 390p from 370p as we incorporate the results of our deep dive into RBS' business. Our fair value estimate is 1.0 times tangible book value and 0.9 times book value as of September 30th.
In our view, RBS destroyed its economic moat—or sustainable competitive advantage—in 2007 with its ill-considered acquisition of ABN AMRO. Enormous losses in 2008, largely a consequence of the merger, resulted in several rounds of government bailouts. UK taxpayers now own more than 70% of the group's shares.
We see RBS' moat trend as stable, as we don't anticipate a significant change to its competitive position. While there are a number of challenger banks in the UK, and we expect them to continue to grow, we don't expect them to pose a significant threat to RBS' competitive position because of the stickiness of retail banking relationships and the continued importance of branch locations for attracting retail customers. We think that the threat of further government interference will fade as the government sells down its majority stake in the bank.
Bulls Say
Over the next few years, RBS will be transformed into a leaner and more focused UK bank as it cuts costs and sheds non-core assets and operations.
RBS dominates the UK commercial banking market with a 30% share of SME lending.
RBS now has more than enough provisions and capital to absorb likely legal and regulatory settlements, and could accumulate £20 billion of excess capital by 2018.
Bears Say
Even more than other global banks, RBS faces a litany of legal and regulatory uncertainty, and lawsuits over pre-crisis US mortgage activities will cost shareholders billions to settle.
RBS's technological infrastructure, built through years of M&A, is shakier than investors realised and will be costly to clean up.
RBS' government-sponsored capital raise left the bank exposed to government interference. It may come under further pressure to put the public's interests before those of shareholders.
