RBS posted surprisingly high profits on Friday — with shares in the UK bank rising 14 per cent. But what caused it: a decline in impairments, or better top-line growth? Lex discusses that question, and how to value the bank now.
This is a live format in which we’ll share our thoughts on a note we’re writing in real-time, and readers will be able to weigh in too on the right. So don’t be shy!
So some good news at last for RBS. It has even managed to drag shares in some of the other UK banks up with it this morning – Barclays is up 2 per cent, Lloyds 1.3 per cent. It is not often in the past five years that RBS has been leading the sector higher. Still, it has not been the worst performer over the past six months
Hello there. I’d just like to start with some share prices…
374.50p – The RBS share price after moving 14 per cent on today’s numbers.
410p – The price to which the UK government has written down its stake.
500p – The average price at which the UK government bought its stake…
So there’s a way to go before a sell-down. And yet I suspect there’ll be talk of a stake sale before long, given how the market was pleasantly surprised today…
We’ve already posted this chart, after all. Look at return on equity.
But does the government really need to wait for a “profit” before it starts selling? It bought shares in the banks to avoid a collapse, not to make a profit on the trade. It has achieved its aim already so should think of selling sooner rather than later. RBS could do without the headache of regular government sniping.
Well, government sniping or not, we have a bank that’s cutting costs at what appears to be a fair clip. We can argue whether it’s sustainable later, but the numbers from the release:
Total expenses were 8% lower at £7,108 million, including £514 million of restructuring costs and £250 million of litigation and conduct costs. Operating expenses, excluding restructuring and litigation and conduct costs (‘adjusted operating expenses’), were down 8% to £6,344 million. Overall headcount has fallen by 8,000 over the past 12 months.
Impairment losses declined by £1,881 million to £269 million. All core businesses showed significant reductions in impairment losses as UK and Irish credit conditions continued to improve. In RBS Capital Resolution (RCR) there was a net write-back of provisions, reflecting disposals at favourable prices.
The usual adjusteditis in bank reporting. Still: big impairment move.
The big excitement of the day is all around impairments. RBS’s impairment charge fell from £1.1bn in the second quarter of last year to a £93m credit this time around. Here is the long term progression of RBS’s impairments.
Note the huge charge in the fourth quarter of last year.
The cynical interpretation of all this is that, having been very pessimistic at the end of last year, RBS has given itself the flexibility to surprise on the up-side and produce better than expected results in the following quarters. Like today’s. If share price performance is all about under-promising and over-delivering, then RBS seems to be getting it right. But do big swings in impairment charges really constitute a good reason to buy shares in a bank?
Okay returns, assuming today’s results not a fluke. But capital strength still scares me
Capital strength seems to be improving, and good results like those just reported will help, if the progress can be maintained. Still, on the analyst call there was a question about dividends and buybacks, both of which seem a long, long time off.
And on capital – the ratios in question. Also watch those risk-weighted assets.
So we’re a little dubious about the scale of the impairment change, I take it. OK, what about top-line growth here? That’s also rather important to what sort of UK focused bank is becoming – Retail? Corporate? A big brother to Lloyds?
Here, RBS had some soothing words about SME lending, but top line income for the first half of the year slipped 6 per cent.
If RBS is going to grow, then it is the retail bank that will have to do the heavy lifting. Here’s a chart from Bernstein:
And it is the retail bank that will produce the returns. Here’s more Bernstein (which is bullish on the stock):
Right, but if I want a UK retail bank, why don’t I just buy Lloyds and have done with it?
Perhaps because Lloyds is more expensive, at about 1.4 times tangible book value vs nearer 1 times for RBS.
But remember that those valuations take account of different expected returns. Based on data from Berenberg, consensus forecasts put Lloyds’ return on tangible equity at 14.4 per cent in 2015 while RBS is expected to deliver just 7.4 per cent.
Although note that on a PE basis the valuations look very different – RBS is on a 2015 PE of just over 12, while Lloyds is on just over 9.
Actually, we’ve been debating on Lex before now whether it might be time to start valuing banks on P/E again (as E returns). The UK’s economic recovery has crept up on plenty of investors, after all. Is this one of those times? Does it favour RBS though?
So RBS has plenty of room to improve the return on tangible equity, or is it structurally too different?
Perhaps one of the reasons for that lower expected ROE is that, despite progress made by Stephen Hester and Ross McEwan (former and current chief executives), costs are still high.
Here are two very telling charts – showing costs in 2007 and costs now – from our colleague Megan Murphy over at fastFT
I think this is probably as good as it gets, surely credit costs can’t be lower than this in normal times and operating performance will be somewhat better.
There is scope for the impairments line to help the P&L account for a while yet as economic recovery in theory leads to an unwinding of provisions. I think the operating performance, in terms of new lending, is the big question mark for RBS.
Speaking of costs – perhaps we should look to Malaysia for a warning sign regarding how easy it will be to cut fat.
We noted below that the cost-to-income ratio for RBS in the year’s first half was 71 per cent – or 64 per cent if you adjust for restructuring. It’s high either way.
Now note what we said in a recent note about Malaysia’s CIMB taking on a chunk of RBS operations:
In 2012 it bought a big chunk of Royal Bank of Scotland’s Asian business, but the deal has not been an unqualified success. Regional presence has certainly improved – the bank has been involved in debt issues as far away as Australia. But many new operations are in higher cost countries; CIMB’s cost to income ratio jumped from 56 per cent to 58 per cent and its return on equity has softened. The deal is yet to bear fruit.
Stubbornly high cost to income ratios are not unique to RBS though. Lex took a look at cost to income ratios across the European banking sector last year. They were no lower then than they were a decade previously.
On the cost topic, if I was making a bet on this bank, I would sleep better if I saw a clear pattern of extraordinary costs coming down. And looking at restructuring, litigation and conduct, and PPI costs, I’m not seeing such a pattern. The last 10 quarters, in millions of pounds:
I see PPI cost coming down in the last two quarters, but a continuous smear of non-operating costs otherwise
And then there was this little comment from the Boss, on page one of the release
“But let me sound a note of caution. We are actively managing down a slate of significant legacy issues. This includes significant conduct and litigation issues that will likely hit our profits going forward. I am pleased we have had two good quarters, but no one should get ahead of themselves here – there are bumps in the road ahead of us.”
SD – given that Citizens, the US business, is being floated off and the investment bank is being heavily cut back, the growth will have to come from retail and corporate.
On the retail side economic growth will help but it will be tough for RBS to take a lot of market share – the UK competition authorities are already looking at concentration in the retail and small business banking markets.
On the corporate side, RBS will have to prove that it is possible to grow in corporate banking without having an investment bank.
@ just looking – right you are – thanks for catching the typo
In all then, a pleasant morning for Ross McEwan (if not for analysts and journalists who thought that RBS would say nothing about its results until next Friday when the full set of numbers is due.)
The progress on impairments is encouraging, if it is a sign that the economic improvement is finally being felt in banks’ balance sheets and income statements. But provisioning is always something of a judgement call from the banks (and is about to become more so with new accounting rules). The lower costs are also encouraging but there is much further to go here.
But it is difficult to be really confident about RBS – or about any of the banks – until there are signs that deleveraging is over and economic recovery is starting to show through in lending volumes.
With that, we’ll bring this session to a close. We’ll do another in the near future, but in the meantime many thanks for all your comments.