The Royal Bank of Scotland Group (NYSE:RBS) reported a lukewarm performance for the third quarter of the year last Friday, November 1, with a series of one-time charges pushing results for the U.K.-based banking giant into the red after two considerably better quarters this year.  While top line figures were noticeably hit by a reduction in overall fee revenues, the credit quality also remained strained over the period, resulting in higher impairment losses. The net result was that operating income shrank to less than half of what it was in the previous quarter as well as in the same quarter last year. In fact, Q3 2013 was operationally the worst quarter for RBS since Q4 2011.
To make things worse, the bottom line was dragged down further by a near £500 million (~$800 million) accounting charge from a revaluation of its own-debt and a £250 million ($400 million) charge towards payment protection insurance (PPI) redressal. Quite notably, RBS has now set aside £2.4 billion ($3.8 billion) to repay customers it sold PPI products to since early 2011.
Having been under pressure to split itself into a “good” bank and a “bad” bank by its biggest shareholder – the British government – for quite some time now, RBS detailed its plan taking the middle path and stopping just short of a complete split-up, by agreeing to create an “internal bad bank” that will house £38 billion ($61 billion) of the bank’s non-core and non-performing assets. These assets will be sold off or allowed to run down over coming years. Besides this, RBS has also agreed to accelerate its exit from the U.S. retail business under the Citizens and Charter One brands, to shrink its investment banking operations further, and also to “aggressively” cut down expenses for core operations. 
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Investors were clearly not in favor of any split in RBS – internal or otherwise – as evident from the sell-off triggered in the bank’s shares following the news on Friday, which led to an 8% decline in their value. We maintain a $11 price estimate for RBS’s stock, which is slightly ahead of the current market price.
Retail Banking Operations Continue To Improve
One of the biggest factors behind RBS’s overall strategy in recent quarters has been the pressure exerted by the U.K. government on it to make sweeping changes to its business model. In keeping with these directives, RBS has reduced its investment banking operations to a fraction of its pre-2008 size, and has shifted focus to its retail and corporate banking businesses in the U.K. And this move seems to be paying off.
With an operating profit of £517 million ($825 million) in Q3 2013, the bank’s retail business in the U.K. posted its best performance since Q2 2011 as a healthy improvement in fee and commission revenues was complemented by sequentially lower provision figures for the business unit. The continued growth in size of the bank’s deposit base, which reached £113.4 billion ($181 billion) by the end of the quarter is a great sign as it points towards improving customer sentiments towards the bank.
Ulster Bank Losses Will Be Contained Further By “Bad Bank”
One of the biggest drags on RBS’s results since the recession of 2008 has been the impairments it recorded each quarter on its Ulster Bank operations in Northern Ireland. The Ulster Bank business stuck out as it piled on impairments between £200 million and £400 million every quarter since late-2009 – often representing a third of the group’s total impairments in a given period, while contributing less than 5% of the group’s total revenues.
Impairments from Ulster Bank fell to the lowest level in more than three years in Q3 2013, with RBS setting aside £204 million ($325 million) for the troubled division. This helped the division report its lowest loss figure for a quarter since the downturn.
With RBS announcing its decision to house all its bad assets under the soon-to-be-created internal bad bank, the worst performing Ulster loans will be promptly moved under the umbrella segment. This will no doubt help RBS manage its Ulster bank operations better as a going concern.Notes:
- Q3 Results, RBS Investor Relations Website, Nov 1 2013 [↩]
- RBS and the case for a bad bank: the government’s review, U.K. Government Report, Nov 1 2013 [↩]