RBS’s Poor Q4 Results Accompanied By Plans To Exit Markets Business In 25 Countries
The Royal Bank of Scotland Group (NYSE:RBS) reported worse-than-expected results for the last quarter and full-year 2014 on Thursday, February 26, as a lukewarm operating performance for the period was only made worse by a long list of one-time costs. [1] The U.K.-based banking group incurred an accounting charge of £4 billion ($6.2 billion) from a reclassification of its stake in Citizens Financial Group, a tax charge of £1.9 billion ($3 billion), and a conduct-related charge of £1.2 billion ($1.8 billion) to cover litigation costs for the ongoing foreign exchange investigations as well as to redress customers for mis-selling PPI and interest rate hedging products. As a direct result of these expenses, RBS reported a net loss for Q4 2014 which was large enough to drag its full-year results deep into the red. The bank has now reported a loss for seven consecutive years.
But things weren’t all bad for RBS in Q4. Most notably, the bank’s loan charge-offs remained at one of the lowest levels since the economic downturn – allowing it to release another £670 million ($1 billion) in loan provisions for the period. This compares to a total impairment loss in excess of £5 billion ($8 billion) in Q4 2013. RBS also managed to comfortably surpass its target of slashing £1 billion in recurring costs by the end of 2014.
With an eye on long-term sustainability, RBS is also looking to implement drastic cuts in its investment banking operations over coming years and will shrink the balance sheet for its Corporate and Institutional Banking (CIB) division by 60% within five years. This move will help RBS make significant progress on several fronts. Firstly, it is in line with the directive issued by the British government (which owns 79% of the bank) for RBS to focus its efforts on its U.K. retail and commercial banking operations. Secondly, it will help improve the weak operating margins for RBS’s investment banking division. And finally, the sale or closure of the capital-intensive units should boost the bank’s capital ratios – taking it closer to the stringent Basel III capital requirement target.
Investors clearly weren’t very happy about RBS’s results – especially the bank’s growing legal burden. The long-term plan to shrink its investment banking arm did not alleviate their concerns much, as a sell-off resulted in the bank’s shares losing almost 5% of their value over trading on Thursday. We maintain a $12.50 price estimate for RBS’s stock, which is slightly ahead of the current market price.
See our full analysis for RBS’s stock
Global Investment Banking Operations To Be Reduced
RBS arguably underwent the most extensive reorganization among all the global banking giants in the wake of the economic downturn, with the bank reducing total jobs across its operations from 226,400 at the end of 2007 to less than 109,000 at the end of 2014 – a reduction of more than 50% over this period. A large part of this downsizing was mandated by the European Commission (EC) as a condition for RBS’s bailout. However, 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. It was only a matter of time before RBS threw in the towel and implemented huge cuts to its capital-intensive investment banking operations, so the recently announced plan comes as no surprise.
As a part of the large-scale reorganization plan for the CIB business, RBS will only retain trading operations in select Western European countries besides its main distribution and trading hubs in the U.K., U.S. and Singapore. Notably, the bank will exit from large Asian economies including China, Hong Kong and India – reducing its global presence from 38 countries now to just 13 countries in the near future. [2] In the process, the bank targets a reduction in the size of CIB’s balance sheet from £107 billion at the end of 2014 to £35-£40 billion in 2019.
We believe that this move will affect RBS’s FICC (fixed-income, currencies and commodities) trading revenues the most over coming years, as they will shrink steadily along with the sale/closure of individual trading desks around the globe. The chart below captures our forecast of the bank’s FICC trading revenues in the future, and you can see how changes to these revenues affect’s RBS’s share price by making changes here.
Reining In Operating Costs, Clearing Legal Backlogs Remain Top Priorities
Last February, RBS announced plans to cut its cost-to-income ratio to 55% within three years and to under 50% in the long run. [3] This involves considerable effort on the bank’s part, given that the cost-to-income figure was 95% for 2013 and 87% for 2014. Even after nullifying the impact of one-time restructuring costs and conduct-related expenses, the adjusted cost-to-income figures of 72% and 68% are way too high for the bank to generate sustainable profits. This explains why the bank has been working frantically to explore additional ways to slash costs. Having cut recurring costs by £1.1 billion in 2014, RBS is now targeting a reduction in total recurring costs by another £800 million in 2015.
While the proposed changes to the CIB division will be an important step towards achieving the operating efficiency goal, most of the improvement is expected in RBS’s U.K. Personal and Business Banking division. The division reported a cost-to-income ratio figure of 72% for FY 2014 (adjusted figure of 55%), as it continues to be plagued by multi-million pound customer redressals for wrongly selling investment products in the past. The partial impact of improving cost-to-income ratios on RBS’s share value can be understood by making changes to the chart below, which captures the operating expenses of its U.K. retail banking unit as a percentage of the division’s revenues.
View Interactive Institutional Research (Powered by Trefis):
Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
More Trefis Research
- Annual Results 2014 Announcement, RBS Investor Relations, Feb 26 2015 [↩]
- RBS Said to Plan Cutting Footprint to 13 Nations in Revamp, Bloomberg, Feb 25 2015 [↩]
- A new direction, RBS Press Releases, Feb 27 2014 [↩]