RBS: One For The Long Haul

Published in Company Comment on 5 May 2011

Royal Bank of Scotland could be very rewarding for patient investors.

There's a share, a major FTSE 100 company into the bargain, that had net tangible assets at 31 December 2010 of 51p, its own figure in the annual accounts, whilst its current price is about 40p. 

If you believe as I do that Price to Tangible Book (P/TB) is the king of the value ratios then this has to be attractive at 0.78. The share is Royal Bank of Scotland (LSE: RBS) and the assets per share takes account of both the ordinary and B shareholders to be as conservative as possible.

Why now?

I'm writing about it now because of a sizeable fall in bank shares on Thursday which caught my eye. It doesn't really matter to me why bank shares fell, just that they did.

For those who think there has to be a reason for every move, which I don't, this is due possibly to poor figures from Lloyds Banking Group (LSE: LLOY) which included a big hit from providing against potential liabilities for mis-sold loan payment protection insurance.

It's an ephemeral issue to which the market has over reacted, in my view. Nobody is going to recall what that was all about a few years down the line and it's all just general poor sentiment providing a possible buying opportunity, value style.

The banking recovery

The bank recovery is a long time coming and for RBS it maybe the longest of them all. 

RBS was one of the biggest casualties of the financial collapse but worse than that, it has the dubious distinction of being one of those that actually caused it. It was bust at the time and saved from going under only by massive government aid to the extent of holding over 80% of the share capital now.

But unlike fellow, but far smaller, bust bank Northern Rock which was wholly nationalised and thereby lost everything for shareholders, RBS was permitted to retain its stock market listing, thus leaving room for investors including the government to try and recover some money out of the disaster eventually.

Make no mistake, RBS aint no pyad share. It hasn't been, and won't be, paying dividends for years, and makes losses. Of course, being a bank, it has a lot of debt because, well, that's how banks operate -- they borrow at one rate, lend higher. 

So it's a one leg job out of the four that form the deep value plays in my book. But book is the one thing it has got, plus I like the fact that it's still a very big cap, bigger than most at around £44bn, even on its present mickey mouse price of 40p. That's compared with about 600p in early 2007, so imagine how gargantuan it was back then.

Bigger is better

I've written before that a big cap value play is usually preferable to a smaller same, assuming otherwise similar numbers. 

The reason is that in the markets, bigger is better from a survivability point of view and when the chips are down, as they most certainly were for RBS in the depths of the collapse, size matters. That sheer mass of the company was probably the reason it remains listed rather than the government NRocking it into full nationalisation.

People generally have more interest in trying to ensure the survival of a very big business than a small one for several reasons such as jobs, international considerations and so on. Size isn't a big consideration in my style of value investing, in fact most good or pyad plays are much smaller businesses, but it is a dab of icing on the cake if it's there.

The long view

If you are interested in RBS, you must look upon it as a longer term investment. All value plays require patience but this one will likely test that to the limit especially as there is no yield to sweeten the wait. 

It's a risk, you are banking literally on recovery to a profitable business with dividends resumed and the rest of it. But this risk I see as having very high upside and pretty limited downside. 

I'm not saying it will go back to its recent peak of 600p any time soon, but it does look like a share which could multiply itself several times in a period of years and could deliver a very high average annual return, if you can wait it out.

The government will eventually sell its stake though it's arguable what signal that would give. Typically, investment decisions by bureaucrats are wrong, so a sale could signal the start of a good uptrend. Or, this could be the one in a hundred they get right and it marks the top of a trend. So the likelihood in my view is that a government sale of its RBS shares is far more likely to indicate rises to come.

The downside

And what's the worst that can happen? Well it could go under, losing you the lot via a full nationalisation. Any share can go bust but my guess though is that this is now fairly unlikely with RBS, given that it didn't happen in the darkest days of the last few years.

A more likely outcome perhaps is that the shares go nowhere for years because the recovery just doesn't really work out. So it staggers along, dividendless, perhaps in a narrow trading range as it has already for some time, wearing you down. Eventually you can get fed up and sell.

I don't think this latter outcome is what will happen though it could easily persist for some time to come. Sooner or later I expect that RBS will do the business and do it handsomely but don't hold your breath. 

One to put away for the long haul, but that long haul could be especially rewarding in this case and right now, they are a little cheaper than recently.

More from Stephen Bland:

> Of the shares mentioned, Stephen holds Lloyds.

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Marklucas1 05 May 2011 , 2:14pm

In recovery situations such as with RBS, I've found two indicators which often work. First is when a share is at serious risk of going bust, and then that risk is lifted. Second is when the Company's business starts reporting improving financials, clearly showing the bad times are behind it.

Applying either of these rules, incurs an opportunity cost. For example RBS looks very unlikely to go bust now but the financials are not yet on a sustained upward trend. By waiting until the good news, the share price will almost certainly have risen. Who knows, say from 40p-60p. That's quite a cost to the investor, but I think worth it to avoid waiting months/years/decades with dead-money for the tide to turn.

F958B 05 May 2011 , 2:37pm

I'm also fascinated by the potential for bank recovery, as are a few well-respected fund managers.
For now, though, I'd be inclined to let the FTSE's correction run its course before moving into bank shares, due to bank shares having a significantly higher beta than than the broader market.
I'd pitch an educated guess at another 10% (ish) decline for the banks, before the current summer correction ends. After that, I'll look more closely.

UncleEbenezer 06 May 2011 , 7:54am


What is tangible book value? Above all, in a bank!

Not so long ago it would've included face value on all those AAA mortgage-backed bonds. Today it includes [...]

Prof103 09 May 2011 , 11:54am

Mark Lucas1 wrote:-
"Who knows, say from 40p-60p. That's quite a cost to the investor, but I think worth it to avoid waiting months/years/decades with dead-money for the tide to turn."

Exactly my thinking. I sold a large chunk of RBS to release dead money from a range-bound share two years ago. I retain a large chunk as a possible long term recovery. I regard it as a sleeper. I would not invest extra cash at this point for the reason you so well describe.


4spiel 09 May 2011 , 1:45pm

Well RBS is the owner of NAT WEST. I hold a number of RBS and collect my dividend from NAT WEST PREFERENCE SHARES ! Yes have your own hybrid. NWBD have been going up lately -so maybe not best time to buy . NWBD (9%) pays half yearly in April and October and is required to pay a stock dividend if cash defecient .1000 NWBD and 500 RBS gives you a 6% yield tax free in an ISA.

AlysonThomson 10 May 2011 , 10:54am

I don't think so. I'm still holding Lloyds TSB for the long term!!!!!

AlanShouls 21 Jun 2011 , 7:42am

Hi - I would have a couple of concerns - Greece and Ireland.

A really quick search yielded the following about Greece:
Royal Bank of Scotland Group (RBS): Credit exposure, Greece under GBP1 billion (personal, sovereign, banks/financial institutions/corporate).


And I found the following about Ireland in the Telegraph
Royal Bank of Scotland's Irish loan losses double to £15bn after stress tests, says UBS.

What will happen with Greece and Ireland I don't know - but currently it looks like Greece is in a barely controlled fall. I can't see anything but it will have to default - but this is a guess. If it does default then what happens to the banking sector could be big, and the fallout could well include restructuring in Ireland - who knows.

So if RBS has another 8 billion that could be bad - would this come off the "book value" (I am afraid don't know). RBS as of today has a market cap of about 19 billion so it would seem like a dent.


AlanShouls 21 Jun 2011 , 7:46am

oops market cap of RBS is 23.6 billion - my bad ;-)

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