RBS: Litigation Costs Could Depress Future Earnings

Despite a rise in profits, Royal Bank of Scotland's shares trade still have a very high uncertainty attached to them, say Morningstar equity analysts

Derya Guzel 27 April, 2018 | 3:20PM
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Royal Bank of Scotland

Royal Bank of Scotland (RBS) made £792 million of profit in the first quarter, more than triple its £259 million in the same quarter of 2017 as costs declined 18%. Despite this increase in profits Morningstar equity analysts are maintaining our fair value estimate of 290p per share. The shares trade in three-star territory with very high uncertainty attached to them. We also maintain our no-moat ratings, which means it has no competitive advantage. Lloyds remains our preferred name in UK banking.

While earnings are currently trending in line with our full-year estimates, we believe some downside risk remains in the form of US Department of Justice litigation costs related to residential mortgage-backed securities. Regarding the litigation cases in the United States, as of December 31, 2017, RBS had a total provision of around £3 billion for ongoing matters including legacy residential mortgage-backed securities (RMBS) activities.

In the Justice Department case, considering the historical and recent fines issued in this matter – Barclays’ case came in lower than what the Justice Department was asking for – we estimate the total cost related to RMBS to be between £3 billion and £4 billion. However, because the duration and outcome of the department’s investigations and other RMBS matters remain uncertain, further substantial provisions and costs may be recognised, leading to downside risk to future earnings.

Management indicates that as soon as it reaches a settlement, it hopes to reinitiate its dividend payment. RBS's last dividend payment was in 2007. We believe dividend payments should resume only once the bank is back to decent financial health and has resolved its Justice Department RMBS case. In our model, we don’t forecast any dividend payment for 2018-22.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
NatWest Group PLC413.90 GBX0.34Rating

About Author

Derya Guzel  is an Equity Analyst for Morningstar

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