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RBS – still going in the wrong direction…

Friday, February 24th, 2017

“We are no longer a bank with global aspirations”
This is a bank all about downsizing.

RBS:
still in losses
still wiping out capital
10 pages of clean up costs and risks from past misbehaviour (more than HSBC which is 2-3 times larger)

And the momentum is in the wrong direction
pre tax Loss INCREASED from £2bn to £7bn
Capital ratio DOWN from 16% to 13%
Litigation and conduct costs UP from £3.5bn to £5.1bn

A bank can only keep wiping out equity capital for so long before it needs new cash.  In 2016 the RBS CET tier 1 ratio reduced from 16% to 13%, 3% points of equity capital was wiped out in one year alone.

If RBS reports the same loss for 2017 then assuming a further 3% points of equity capital is wiped out, it takes the CET tier 1 ratio to 10%.  For comparison the Co-Op Bank has a CET 1 ratio below 10%” where it will remain in the medium term”.  And Co-Op bank is on fire sale…..

Now of course most analysts are not forecasting another £7bn loss in 2017, but they didn’t forecast that loss in 2016 and most of the scale of losses of the past. This is RBS’s ninth year of consecutive losses, totalling £58bn,  and virtually every one has been larger than analysts and RBS executives had expected.  And the year that the bank was finally expected to move into the black and report a profit has been put back further and further into the future.

In total the bank took about £10bn of one off costs, including a £5.8bn litigation and clean up costs and £2bn restructuring costs.

And remember there is still 10 pages of potential risks to RBS from mis-behaviour ranging from manipulating markets (IDSDAFIX, LIBOR, FX, USTs) to the tax investigation uncovered with Mossack Fonseca, problems at Coutts, and the big potential one – the costs of settling with the US Department of Justice over the bank’s role in the US mortgage backed securities fraud.  Analysts at UBS note that “our analysis of the 7 settlements reached so far has not left us confident that the £4.6bn of excess capital RBS has will be sufficient to settle the potential bill.”  For comparison Deutsche Bank settled with the DofJ for $7.2bn.  RBS management were  extremely reluctant to talk about this settlement during the investor presentation. 

The £2bn of restructuring charge is the cost of taking costs out of the business.  RBS has a cost to income ratio still above its peers (CFO: “least efficient bank” in UK).  So RBS will need to continue to take such charges, wiping out profits.  The bank’s target cost to income is below 50%.  There is a long way to go to get there and Lloyds is already doing better than that and its target is 45%.

The bank has cut its staffing costs by 10% in two years from £5.6bn in 2015 to £5bn in 2014.  There will be more to come and that means more restructuring charges.

And despite the losses, RBS still paid £1bn tax partly thanks to the government’s bank levy.  That £1bn charge is not inconsequential and writes off £1bn of equity capital. 

I see all of these three charges- clean up costs, restructuring and tax – continuing.   But CEO Ross McEwan promised in the presentation that there will be “substantial one off costs in 2017 but they should fall off in the following years”. He needs to be right as the bank does not have the capital to continue with the scale of losses of the past. 

What these results show is that badly run banks take an awful long time to clean up and that the problems are always under estimated.  It is what we have learnt from the financial crisis. As Buffet says “it is only when the tide goes out do we discover whose been skinny dipping”.  Well with RBS, Co-Op Bank, Deutsche Bank and most Italian banks, we first discover one skinny dipper, then another, then those swimming in the buff tend to increase almost exponentially.

At the same time the British taxpayer owns 73% of RBS. And that appears to be is influencing how the bank is run.  What most Britons don’t realise is that the big risk to banks is not from their wild and crazy investment banks (although that can be a large source of risk) but actually their massive mortgage loan books. And what is really interesting is that Lloyds bank (smart, well run) announced this week that is was not competing aggressively for market share in mortgages as it worries for its margin and clearly think there is some risk to over lending in a housing market that has boomed.  RBS is doing the complete reverse, increasing lending to consumers by 10% in 2016, primarily in the mortgage business.  Will RBS aggressive and over zealous lending get it into difficulties in the future? 

And its the same with commercial lending.  As a state owned bank, RBS must be under pressure to increase lending to business as well – lending to small business was up 6% in 2016.  And yet commercial lending is notoriously low margin (RBS ROE just 5% in 2016) and always has been.  Again RBS is increasing lending to corporates whereas Lloyds has decided to use its capital to buy a PRIME credit card business from MBNA which has fantastic profitability (Barclaycard ROE > 20%)

Ross McEwan “We’ve grown more than any other UK bank”. 

At a time of great political and economic uncertainty, RBS (the least strong of all the big UK banks) is growing lending to consumers and businesses faster than any other bank.   That is worrying.   

And of course with extremely low interest rates, non performing loans are currently extremely low. At some stage in the future, bad loans will increase’ leaving RBS potentially more exposed than its competitors.

CEO Ross McEwan promised in its investor presentation: “expect one more year of substantial one off clean up legacy costs and that the bank will make a bottom line profit in 2018.”  And that “The next three years will not be the same as the last three years despite the political and economic uncertainties”

The problem for RBS is that it is running out of time and capital to turn a profit.  Lets just hope Ross McEwan is right as if he is not, RBS capital position may look vulnerable. 

And many banks are still raising capital.
Co-Op Bank has had to put itself up for sale to get extra capital. 
Deutsche Bank may need to raise capital still.
So far this year Italian bank Unicredit raised E13bn in its rights issue and Portuguese bank Millenium BCP has raised E1.3bn

Will RBS need more capital in the future?  and who would give it to them?
Right now, on current RBS executive forecasts, no.
But if those forecasts prove as optimist as forecasts have proved to be in the past then it is a possibility.

I would have thought that shares in the bank would have been down more than 1%.  But clearly city analysts have more confidence in their abilities to forecast reduced losses than I have.

A decade on from the beginning of the financial crisis, RBS is still struggling.  And the share price at 240p is at half the level at which the government bailed it out. 
Says it all.

I tweet my thoughts on @Louiseaileen70

 
 

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