Why RBS Is Likely To Retreat From The U.S. Market

RBS: Royal Bank of Scotland Group logo
RBS
Royal Bank of Scotland Group

Over the last month, The Royal Bank of Scotland Group (NYSE:RBS) has announced a series of changes to its operations in the U.S. The U.K.-based banking group will be implementing drastic cuts to its trading and mortgage business in the country and also has plans for an IPO of its Citizens unit. The increasing pressure on RBS (which is majority-owned by the British government) to focus on its retail and commercial banking operations in U.K. over the last couple of years is no secret. However, the flurry of activity over recent weeks has another factor acting as the catalyst – the fact that its U.S. subsidiary failed the Federal Reserve’s stress tests for banks this March.

The Fed included RBS Citizens as a part of the tests conducted this year along with the U.S. subsidiaries of all foreign banks with more than $50 billion in total consolidated assets, and found the unit’s capital planning process flawed. RBS is now looking to shrink its asset base in the U.S. to under the $50 billion mark, in a move likely aimed at steering clear of the stress tests while at the same time pacifying the British government. The steps it announced over recent weeks are precursors to a strategic retreat by the bank from the U.S., with RBS likely to reduce operations in the country to the bare-minimum levels required to offer international banking services to its clients over coming years.

Relevant Articles
  1. Beating S&P500 BY 11% YTD, What To Expect From Travelers Stock?
  2. Up 50% Over The Last 12 Months, Is Hyatt Stock Still Attractive?
  3. Capital One Stock Gained 44% In The Last 6 Months, What’s Next?
  4. Up 8% Year To Date As 5G Gains Traction, What’s Next For Verizon Stock?
  5. Up 32% In The Last 12 Months, Where Is BNY Mellon Stock Headed?
  6. Rallying 30% YTD, What’s Spurring The Rally In Applied Materials’ Stock?

We are in the process of updating our $13 price estimate for RBS’s stock, which is about 15% above its current market price.

See our full analysis for RBS’s stock

RBS arguably underwent the most extensive reorganization among all the global banking giants in the wake of the 2008 economic recession, with the bank reducing total jobs across its operations from 226,400 at the end of 2007 to 118,600 at the end of 2013 – a reduction of nearly 50% in six years. While a large part of this downsizing was mandated by the European Commission (EC) as a condition for RBS’s bailout, in recent years it was also driven by a strategic shift from a highly diversified business model to one focused on retail and commercial banking operations in the U.K. due to sustained pressure from the British government. A gradual spin-off of the group’s operations in the U.S. was announced early last year, and the filing with the SEC last month for an IPO to raise $100 million is the first concrete step in this direction. [1] As you can see from the chart above, RBS Citizens contributes roughly 7% of the group’s total share value and our analysis pegs its total value at just under $3 billion.

The decision to shrink several capital-intensive U.S. operations, however, likely stems from the bank’s need to escape the additional scrutiny which foreign bank subsidiaries with over $50 billion in assets draw from the Federal Reserve. As Citizens currently falls under this category, it was a part of the stress tests for this year – and it failed. Even if the unit addresses the flawed capital planning process pointed out by the Fed by the 2015 test, it will still fail the test as it is not capitalized separately from the global bank holding company. So compliance with U.S. capital ratio requirements will require a capital infusion of several billion dollars into the U.S. subsidiary – something that RBS would clearly want to avoid as it works on strengthening its overall capital structure. It should be noted that the bank lags other global banking giants in terms of common equity Tier 1 (CET1) capital ratio figures.

The operation taking the biggest hit is the bank’s non-agency mortgage business, which will shrink to one-third of its current size and will see a reduction of 300 jobs by the end of 2015. [2] RBS will also cut another 100 jobs in its distressed loan trading unit. [3] While the advantage will be seen in terms of a marked reduction in the bank’s risk-weighed assets in the U.S., there will also be an improvement in margins for its U.S. operations. The chart below represents the staff and other expenses for the Citizens’ operation as a percentage of its revenues. You can understand how this affects RBS’s total share value by making changes here.

See More at TrefisView Interactive Institutional Research (Powered by Trefis) | Get Trefis Technology

Notes:
  1. RBS’s Citizens Financial unit files for U.S. IPO, Reuters, May 12 2014 []
  2. RBS slashes US mortgage business, Financial Times, May 27 2014 []
  3. RBS to Cut Hundreds of Jobs in U.S. Trading Businesses, The Wall Street Journal, May 27 2014 []