RBS Warns Of A Tough Year Ahead As Legal Costs Weigh On Q1 Results

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

The Royal Bank of Scotland Group (NYSE:RBS) reported worse-than-expected results for the first quarter of the year on April 30, as huge one-time costs related to its legal backlog as well as its ongoing reorganization plan marred the lukewarm operating figures for the period. ((Q1 2015 Results Announcement, RBS Investor News, Apr 30 2014)) The U.K.-based bank, which is majority-owned by the British government, ended up with a loss of £446 million ($690 million) for Q1 2015 – a figure that is in sharp contrast to the £1.2 billion in profits reported for the year-ago period. RBS faced headwinds on multiple fronts this time around. While its retail banking, private banking as well as corporate and institutional banking operations saw a notable reduction in revenues year-on-year, the bottom line was negatively impacted by £453 million ($700 million) in restructuring costs. To make things worse, RBS incurred an accounting charge of £122 million from reclassifying its International Private Banking business as a non-core unit, a notional loss of £320 million ($490 million) due to a reduction in the price of Citizens shares, and was also forced to set aside another £856 million ($1.3 billion) as litigation and conduct charges.

But things were not all bad for RBS. The bank’s commercial banking operations in particular had a good quarter, and posted its best pre-tax income figure in over three years. Improving economic conditions in the region helped the bank release its loan provision for the fourth consecutive quarter. And finally, the positive impact of RBS’s efforts to improve operating efficiency is beginning to show across operating divisions in terms of improved adjusted margins – especially for the institutional and corporate banking division.

We maintain an $11.50 price estimate for RBS’s stock, which is roughly 10% ahead of the current market price.

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See our full analysis for RBS’s stock

Weak Period For Retail Banking Operations

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 109,200 at the end of Q1 2015 – 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. The importance of the U.K. retail business to RBS’s value is made clear from the chart above, which shows that these operations account for more than 40% of its total value. So when the division has a weak quarter (as was seen this quarter) the effect is clearly visible in the overall results.

The U.K. Personal and Business Banking division generated £1.45 billion in revenues in Q1 2015 – slightly below the £1.46 billion figure for Q1 2014 and more than 5% lower than the £1.53 billion reported in Q4 2014. The decline stems from a quarter-on-quarter reduction in revenues for each of the division’s revenue streams: personal advance, personal deposits, mortgages, cards, and business banking. Mortgage revenues – which are responsible for roughly 45% of the division’s total revenues on average – saw the largest decline of 6% compared to the previous quarter.

The over-sized conduct charges for the quarter did not help, as total operating expenses swelled 31% compared to the year-ago period. This pushed the division’s cost-to-income ratio to over 78% in Q1 2015 from 60% in Q1 2014. There was a notable improvement in the adjusted cost-to-income ratio, though, as the figure fell to 51% for the period – the best since the economic downturn of 2008 and well below the bank’s target of 55%.

Commercial Banking Business Helped Salvage Results

As the other business RBS has actively focused on over recent years, the commercial banking division did not disappoint and churned out one of its best performances since the economic downturn. The division reported £822 million in revenues in Q1 2015 – a good 7% higher than the figure for the first quarter of 2014. Almost the entire gain can be attributed to higher fee revenues from commercial deposits. Benefits from the cost-cutting drive, and the absence of any one-time expense for the quarter helped the commercial banking division report a strong cost-to-income figure of 50%.

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