No champagne
RBS’s first headline profits this decade and a hint that dividends are 'closer' have not been enough to trigger shareholder applause. The outstanding mortgage-backed securities case is too much of a worry. Lack of a clear update on the Department of Justice litigation means pay-outs are unlikely to start in 2018—dividends can’t be paid before the government has sold its 71% stake.
Worst-case not expected
But Friday’s share price reaction doesn’t assume the worst-case scenario. The loss of about $2.1bn in market value implies RBS (LON:RBS) is expected to pony up more than the $4.4bn it had set aside by the end of last year. But the total would still be around half the most pessimistic charge expected. It would be painful, but absorbable, given RBS’s key capital buffer had strengthened to 15.9% by the end of the year, the highest ratio amongst UK rivals. The scenario does of course require the DoJ to stick to its pattern of mandating settlements below the highest possible; usually contingent on humble co-operation (hello, Barclays (LON:BARC)). But the scenario is a plausible base case. And it would still allow RBS a tentative path to growth and shareholder returns.
Nearer to 'sustainable'
That’s after annual total income comfortably topped quarterly forecasts and operating profit excluding charges rose 31% to £4.6bn in 2017. What’s more, adjusted Return on Tangible Equity – possible shareholder returns once the ‘bad bank’ is sold and excluding one-offs – was 8.8%. Assuming RBS’s end state is in sight, the figure closes the gap to the 12% target at which the group says 'sustainable returns' would be possible.
Innovation costs
Slightly blurred cost goals are less welcome. RBS still targets a less than 50% cost/income ratio by 2020, but an absolute cost target has been scrapped as obligations remain volatile and investments demanding. For instance, a depreciation charge pushed costs to 79% of income over the year from 67.5% in Q3. The group also said investments over two years would be £1.5bn higher than forecast partly due to increasing 'nnovation spend'. Some investors have grumbled about increased spending on Friday so these are likely another reason for the negative share reaction.
A better Good Bank
Indeed, with RBS shares edging closer to book value after outpacing rivals in 2017, the stock is beginning to price a perfect transition. That remains unlikely. With real returns on equity of just 2.2% in 2017 a UK downturn could call all promising bets off. Nevertheless, RBS is still exponentially sounder than looked feasible a few years ago.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient.
Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.