RBS On The Road To Recovery

Published in Company Comment on 4 May 2012

The taxpayer-supported bank loses another £1.4 billion, but is clearly on the mend.

Royal Bank of Scotland (LSE: RBS) unveiled its first-quarter results this morning and saw its shares shoot to the top of the FTSE 100 leader board.

RBS = Ruined Bank Stabilised

As I write, RBS shares trade up 2.6% at 25.2p, valuing the bailed-out bank at £15 billion. This market reaction came despite news that RBS lost another £1.4 billion in the first three months of this year. However, this loss is almost entirely due to an accounting write-down on the bank's own debt.

In the first quarter of 2012, total income at RBS was close to £6.9 billion, down almost 11% on Q1 2011. As a result, core operating profit dropped to nearly £1.7 billion, diving a quarter (25%). After nearly £0.5 billion of losses at non-core businesses, the bank's operating profit came in at almost £1.2 billion, which was 4.5% ahead of a year earlier.

However, RBS ended up with a statutory loss before tax, largely due to an adjustment of almost £2.5 billion in the value of its own debt. As RBS's creditworthiness has improved in 2012, the value of its own bonds has risen. Therefore, this increased liability caused one huge accounting adjustment.

RBS also paid £43 million to the government for the financial protection provided by the Asset Protection Scheme safety-net. In addition, the group set aside another £125 million to meet increased PPI (payment protection insurance) compensation.

The net result of all this accounting malarkey is that RBS recorded a loss before tax of just over £1.4 billion in three months.

Boring banking

Given that British taxpayers bought our stake in RBS for £45.2 billion at an average price of 49.9p per share, we are sitting on a massive loss. As things stand, we've lost around half of our bailout money.

Despite this recent loss, RBS is looking healthier by the day. When (no longer Sir) Fred Goodwin and his merry band of directors were at the helm, RBS's balance sheet swelled to £2.4 trillion. Alas, it was packed with dodgy assets such as subprime mortgage securities, which promptly bombed.

Almost five years on, RBS is a much smaller and more stable bank. Its funded balance sheet (total assets minus derivatives) has dropped to £950 billion, down almost 10% in a year. Assets at its non-core businesses fell another £11 billion to £83 billion as it sold off unwanted items.

As for bad debts and other impairments, these exceeded £1.3 billion, but were still down 33% year on year, helped by lower write-offs in UK retail banking. What's more, the bank's loan/deposit ratio has dropped from 116% to 106% in a year, so RBS has increasingly more cash deposits backing its loan book.

However, one key indicator went in the wrong direction: the Core Tier 1 ratio -- a measure of capital strength -- dipped to 10.8% from 11.2% a year earlier.

RBS = Really Buy Shares?

One other of the FTSE 100 firm's fundamentals weakened: tangible asset value per share slid to 48.8p from 50.1p. Even so, this means that RBS shares trade at just over half (52%) of their underlying asset value.

Stephen Hester, RBS chief executive, said today: "We are happy with progress in the first quarter, though the economic and regulatory backdrop remains tough. RBS continues, markedly, to regain strength and resilience. Our focus is on improving the future for customers and our business, whilst ensuring that the bank's past issues are dealt with."

Clearly, Hester still has plenty of legacy issues to tackle, but RBS is gaining strength and reducing risk. Then again, are its shares now in value territory? I suspect so.

RBS is poised to repay its last tranche of funding from the Bank of England's liquidity support schemes. Also, it is resuming dividend payments and coupons on hybrid securities. These two steps suggest that Hester is confident that RBS is well on the road to recovery.

At 25.2p, RBS shares trade on a forward price-to-earnings ratio of 10.5 and offer a prospective dividend yield of 0.2%, covered almost 47 times. Although these are not compelling fundamentals, we have to bear in mind that this is very much a business in transition.

While I believe that more turmoil lies ahead for financial markets, RBS offers the potential for decent medium-term gains. Hence, a tentative buy now could yield market-beating returns in the years ahead. This is one share to tuck away and wait for 'boring banking' profits to return!

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> Cliff does not own any of the shares mentioned in this article.

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Comments

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CunningCliff 04 May 2012 , 12:11pm

Note that the taxpayer owns 82% of RBS and our stake is worth around £22.8 billion (a loss of £22.4 billion).

However, RBS has a market cap of just £15 billion, because most of the taxpayer's stake is held in special preference shares, not ordinary shares.

This explains the odd discrepancy between the value of UKFI's 82% stake and the current market value of RBS.

Cliff

CunningCliff 04 May 2012 , 12:13pm

By the way, the government's 51 billion 'B' shares carry no voting rights, see:

http://www.investegate.co.uk/Article.aspx?id=201204301537393836C

Cliff

dukindiva 08 May 2012 , 7:41pm

"The net result of all this accounting malarkey is that RBS recorded a loss before tax of just over £1.4 billion in three months."

Hardly a buy signal!

Isn't RBS still horribly exposed to the Eurozone junk bonds of Greece, Italy & others?

Are their coffers resilient enough to cope with the downside of the Euro?

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