RBS’s Failure To Clear Bank of England’s 2016 Stress Test Will Hurt Its Return To The Private Sector

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

The Bank of England (BOE) announced results of the latest iteration of its annual stress test for seven British banks this week, and three of these banks saw their key capital ratios fall below the regulatory threshold under the central bank’s scenario of a severe economic recession in the U.K. [1] Among those that did not clear the stress test, Barclays (NYSE:BCS) and Standard Chartered were able to demonstrate the ability to meet the capital threshold by discontinuing any capital return plans and by converting their loss-absorbing additional tier-1 (AT1) securities. On the other hand, The Royal Bank of Scotland Group (NYSE:RBS) fell short of the minimum figure even after these actions. As a result, RBS had to resubmit a revised plan to the BOE – something that could potentially include plans to raise fresh capital through a stock issuance. [2]

This does not bode well for RBS, which is majority-owned by the British government, and has been struggling to turn its business around since its bailout in the wake of the 2008 economic downturn. Although the bank has slashed its global business considerably over the years, poor economic conditions in Europe have presented considerable headwinds to achieving profitability. This business environment is only expected to get tougher in the near future given U.K.’s impending exit from the EU. Additionally, the bank has a huge outstanding legal burden stemming from legacy mortgage-related lawsuits. The capital woes stemming from BOE’s latest stress tests pose yet another hurdle for RBS, as it will delay the bank’s process of returning to the private sector in the future and will directly impact the bank’s ability to return cash to investors over coming years.

We are in the process of revising our price estimate of $6 for RBS’s stock to factor in the dilution from a fresh stock issuance. The existing price target is about 25% ahead of the current market price.

Relevant Articles
  1. Will Johnson & Johnson Stock Rebound To Its Pre-Inflation Shock Highs of $185?
  2. Should You Pick Eli Lilly Stock After A 4x Rise In Three Years?
  3. Down 9% This Year, What’s Next For Lululemon’s Stock Past Q4 Results?
  4. Down 14% In The Last Trading Session, Where Is Adobe Stock Headed?
  5. Will Higher Federal Government Spending, Gen AI Drive Digital Security Stocks Like CrowdStrike Higher?
  6. Up 30% In A Year Is FedEx Stock A Better Pick Over UPS?

See our full analysis for RBS’s stock

The Bank of England’s stress test for British banks – like the one conducted by the Fed for U.S. banks – is an important tool for the regulator in ensuring that the country’s financial system can withstand an extreme adverse economic scenario in the future. As these tests aim to gauge the strength of the largest British banks under conditions similar to those seen during the economic downturn of 2008, they help the BOE advise individual banks about how much they need to shore up their balance sheets if necessary. The purpose of the stress test is to gauge if banks have enough capital to lend to customers and businesses even under extremely trying economic conditions – and more importantly, to ensure that they do not collapse under this situation.

The table below summarizes the core common equity tier 1 (CET1) capital ratio figure for each of the 7 banks tested by the BOE.

Bank Current CET1 Minimum Ratio in Stress Test Req. Regulatory Minimum
Barclays 11.6% 5.9% 7.8%
HSBC 13.9% 7.6% 7.3%
Lloyds 13.5% 9.7% 7.0%
Nationwide 23.3% 15.0% 8.1%
RBS 15.0% 5.5% 7.1%
Santander (UK) 11.1% 9.9% 7.3%
Standard Chartered 13.0% 5.5% 6.6%

As can be seen here, HSBC, Lloyds, Nationwide and Santander’s U.K. arm remained adequately capitalized even under extremely adverse economic conditions. On the other hand, Barclays, RBS and Standard Chartered saw a sharp reduction in the CET1 ratio to well below their required minimum levels. Taking into account strategic management actions (suspension of dividends and share buybacks) and conversion of loss-absorbing securities, the BOE noted that the minimum ratio under stressed conditions improved to 8.3% for Barclays and 7.2% for Standard Chartered – above the required level for the individual banks. However, RBS could only manage a minimum CET1 figure of 6.1% after these actions. This resulted in the BOE asking RBS to resubmit a fresh capital plan with details on how it intends to make up for the shortfall.

RBS has not paid any dividends since its bailout in 2009, and it was largely expected to resume paying dividends in 2018 after the British government has had a chance to cut its stake in the bank considerably. But plans to raise additional equity in the near future to meet regulatory requirements will very likely delay a dividend payout further. The chart below captures our forecast for RBS’s total payout ratio (including dividends and share repurchases), and you can see how a delay in these payouts affect our estimate for RBS’s share by making changes here.

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. Stress testing the UK banking system: 2016 results, Bank of England Releases, Nov 30 2016 []
  2. Statement re 2016 stress test results, RBS Press Release, Nov 30 2016 []