RBS’s Surprisingly Low DoJ Settlement Means The Bank Should Report A Full-Year Profit

The Royal Bank of Scotland Group (NYSE:RBS) has finally put to rest the nagging issue related to its mis-selling of U.S. residential mortgage-backed securities (MBS) during the run-up to the 2008 recession, by reaching a $4.9 billion settlement with the U.S. Department of Justice (DoJ). The recently announced settlement comes roughly two months after the bank’s $500 million settlement of the same issue with the New York Attorney General, and puts to rest the uncertainty surrounding this legacy issue – paving the way for RBS to focus on its path to privatization after being majority-controlled by the U.K. government for a decade.

While the settlement in itself is great news for RBS investors, the unusually low final settlement amount comes as a pleasant surprise – especially since the figure was largely expected to be higher than $10 billion (with a possibility of it being as high as $16 billion). As existing legal provisions of $3.46 billion will cover a bulk of the much-lower-than-expected settlement amount – and as a portion of the settlement is also tax deductible – we expect the net impact of the settlement on RBS’s results for Q2 2018 and full-year 2018 to be fairly small – something we detail in our interactive model for RBS.

RBS likely to incur an additional after-tax charge as low as just $460 million due to the settlement

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 8 global banking giants: Bank of America, JPMorgan, Deutsche Bank, Citigroup, Credit Suisse, Goldman Sachs, Morgan Stanley and Barclays. 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 $4.9 billion will result in an after-tax settlement cost of $3.92 billion for RBS

• Calculating one-time charge that will be incurred: The $3.92 billion after-tax figure will not reach the bottom line completely, as RBS has set aside $3.46 billion over the years to cover the DoJ settlement. The estimated one-time charge incurred could therefore be as low as just $460 million.

This Bodes Well For RBS’s Results For 2018, And Its Valuation

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 $460 million. Assuming the number of shares remain at the current level of 5.95 billion, this works out to a reduction in the bank’s EPS forecast by less than 8 cents for 2018.

More specifically, using our estimate of $17.5 billion for RBS’s revenues in 2018 and a net margin of 14.2%, we forecast RBS to report a net income figure excluding the settlement of just under $2.5 billion. Taken together with the one-time charge of $460 million, this works out to a net income figure of just over $2 billion for RBS in 2018.

Assuming 5.95 billion shares for the bank, this represents an EPS of $0.34. Using a forward P/E ratio of 25, this implies a price estimate of $8.50 for RBS – about 10% higher than its current market price.

In case you disagree with any of our forecasts, feel free to modify them in our interactive model to come up with your own forecast for RBS

What’s behind Trefis? See How it’s Powering New Collaboration and What-Ifs
For CFOs and Finance Teams | Product, R&D, and Marketing Teams
More Trefis Research
Like our charts? Explore example interactive dashboards and create your own