RBS continues to flounder as restructuring and litigation costs bite

Added 28th October 2016

Royal Bank of Scotland has continued to flounder in what it described as the “current low interest rate and low growth environment,” returning £469m in attributable losses, compared with a £940m profit the year prior.

RBS continues to flounder as restructuring and litigation costs bite

Third quarter losses were down relative to the previous quarter’s £1.1bn hit, however.

Restructuring and litigation costs continued to weigh heavily upon the bank throughout the period, escalating to £469m and £425m, respectively.

In Friday’s trading update, RBS revealed that it no longer expects to achieve the 2019 cost-cutting goals and return on equity targets detailed in 2014.

One of the biggest items on its agenda, the disposal of 300 branches of Williams & Glyn, will no longer be achievable by 2017 as RBS had previously stipulated. As part of its £45bn bailout during the financial crisis, RBS was required by the European Union to divest the business. Since then, the bank has spent billions in restructuring costs and agonised over the separation of the business, rejecting an initial public offering option recently.

Despite these expenditures, RBS reported an operating profit of £255m. In Q3 2015, by contrast, the group posted an operating loss of £14m.   

But Old Mutual Global Investors’ UK Equity Income manager Stephen Message argued the overhanging restructuring and litigation issues is what continues to make RBS’ investment story so much less compelling than those of its peers.

“Judging from the numbers today, RBS is performing reasonably well. However, there are still a number of litigation and government overhangs on the horizon. These troubling unknowns keep RBS from looking attractive relative to Lloyds and Barclays, which have much cleaner and simpler investment stories, are on broadly similar valuations and provide an easier route to returns.”

Also, as an equity income fund manager, Message does not like that RBS isn’t paying its dividend and worries it will be some time before the bank is in a position to do so.  

Shares in the bank were initially up during early morning trading on Friday before dipping 2% to 192.4p at the time of writing. RBS’ share price has had difficulty recovering from a slew of scandals and quarterly losses, which is why The Share Centre’s investment research analyst Graham Spooner said it is still prudent to avoid the stock and continues to recommend it as a ‘sell.’

“As a result of the ongoing restructuring, the group is set to shift its business towards retail and commercial banking. The CEO's restructuring plans will indeed shrink the group further, through to 2020,” Spooner said.

“We believe there are better opportunities to be had in the market and our preference is HSBC for those interested in the sector as it is viewed as being more conservatively managed with a superior balance sheet and deposits,” he added.

However, Message thinks that RBS and its peers could begin to look more attractive if the Bank of England and UK government begin to pursue a fiscal policy route.

“The banks need a more favourable interest rate environment, a steeper yield curve or a combination of both. I think we are starting to see acknowledgment from central banks and governments that the world of lower yields and quantitative easing is having a detrimental effect on bank markets and the economy,” Message remarked. “It would be a heroic assumption to think that the transition from monetary to fiscal policy is going to be plain sailing, but the mood music is starting to change.”

And because a switch toward fiscal policy should be more inflationary, Message expects to see an uptick in bond yields that will make it easier for the British banks to be profitable.

“All this talk of fiscal policy explains why some ban shares have started to pick up in the short-term,” he said. “Returns on equity can get higher and multiples on those companies can start to increase. We are certainly not there yet but the direction of travel is starting to change. I don’t want to suggest that my outlook on the sector is totally bullish currently but it is important to note that valuations aren’t particularly stretched at the moment.”    

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