How Would Multi-Billion Dollar Mortgage Fine Impact RBS’s 2018 Results?

The Royal Bank of Scotland Group (NYSE:RBS) is reportedly close to inking a settlement with the U.S. Department of Justice (DoJ) and other state agencies over its mis-selling of residential mortgage-backed securities (MBS) worth billions in the U.S. during the run-up to the 2008 recession. A deal could finally put to rest the uncertainty surrounding this legacy issue, and allow RBS to focus on its path to privatization after being majority-controlled by the U.K. government for nearly a decade. While this is good news for RBS investors, the final fine amount will have a material impact on the bank’s results for the year. After all, the bank reported an adjusted net income figure of less than $1 billion for 2017, and is expected to pay above $10 billion to settle with the DoJ.

We capture the financial impact of a settlement on RBS’s 2018 results in our interactive model, which is based on our estimate that the final settlement amount for RBS will be around $13 billion. Taking into account the tax-deductible nature of a part of the fine, and the provision figure of $4.4 billion already set aside by the bank towards this settlement, we estimate that RBS will incur an additional after-tax charge of around $6 billion this year.

We arrive at this figure in two simple steps:

• Calculating the after-tax settlement cost: Since 2013, the Department of Justice (DoJ) has reached settlements in its other MBS-related lawsuits with 7 global banking giants: Bank of America, JPMorgan, Deutsche Bank, Citigroup, Credit Suisse, Goldman Sachs, and Morgan Stanley. Notably, a significant chunk of each of these settlements was tax deductible. This lowered the impact of the settlement on their bottom lines. Using these older transactions as a reference, we estimate that up to 80% of RBS’s settlement figure will be tax-deductible. Taken together with an effective tax rate of 25%, this implies that a final settlement of $13 billion will result in an after-tax settlement cost of $10.4 billion for RBS

• Calculating one-time charge that will be incurred: The $10.4 billion after-tax figure will not reach the bottom line completely, as RBS has set aside about $4.4 billion over the years to cover the DoJ settlement. The estimated one-time charge incurred would, therefore, be around $6 billion.

As the one-time charge is an after-tax estimate, this indicates that a $13 billion settlement would reduce RBS’s net income for 2018 by $6 billion. Assuming the number of shares (ADS) remain at the current level of 5.9 billion, this works out to a reduction in the bank’s EPS forecast by almost $1 for 2018.

Also, a detailed explanation of how we arrived at our $13 billion estimate for the settlement amount is available here.

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