Cost Discipline Should Help RBS Tide Over Expected Brexit Headwinds In The Near Term

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

The Royal Bank Of Scotland Group (NYSE: RBS) recently released its Q1 2019 results. The British banking giant reported Revenues of £3.0 billion, down 8% (y-o-y) as it continued to face challenges due to uncertainty surrounding Brexit. Notably, the bank’s net interest margin decreased by six basis points from 1.95% in Q1 2018 to 1.89% in Q1 2019 – in turn resulting in a 17% reduction in pre-tax profits.

Per Trefis estimates, RBS’s shares have a fair value of $8, which is roughly 20% ahead of the current market price. We have summarized our full-year expectations for RBS in our interactive dashboard How did RBS Fare in Q1 and what’s the outlook for full-year 2019? You can modify any of our key drivers in the dashboard to gauge the impact of changes on the bank’s valuation. Also, you can see more Trefis Financial Services company data here.

A Quick Look at RBS’s Revenue Sources

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RBS reported £13.4 billion in Total Revenues in Fiscal 2018. This included 2 primary revenue streams:

  • Net interest income: £8.6 billion in FY 2018 (65% of Total Revenues). This represents interest earned through loans and other assets net of interest paid to deposits.
  • Non-interest Income (Fee & Commission Income): £4.7 billion in FY 2018 (35% of Total Revenues). This includes fees for general banking products, services and revenues from wealth structuring solutions and other related fees.

Key Takeaways From RBS’s Q1 Results

Lending Growth Remains Fragile

  • RBS’s total loan portfolio was £306.4 billion in size at the end of Q1 2019, marking a sequential growth of just 0.4%. Notably, the bank’s UK Personal Banking loan portfolio (which constitutes roughly half of its total loan portfolio), grew 1.1% as a result of higher mortgage lending and lower redemption. But Brexit-induced economic uncertainty  has led to reduced consumer confidence and investment activity, which adversely affected the bank’s commercial lending portfolio.
  • With Brexit talks yet to yield any results, corporates in the region have been delaying business borrowing decisions. This is expected to hurt the bank’s loan growth in the near term.

Cost Cutting Measures To Continue  

  • RBS has been extremely successful in reducing its costs over the years, with non-interest expense falling from £16.3 billion in 2015 to £9.6 billion in 2018 (indicating a 16% reduction in costs on average each year). This helped the bank improve its adjusted cost efficiency ratio to 72% in 2018 from a high of 127% in 2015.
  • During Q1 2019, the bank reduced its operating costs by more than £45 million and remained on track to achieve its £300-million cost reduction target for the year. These cost cutting measures coupled with growth in revenues will likely reduce the adjusted cost efficiency figure to 66% in 2019.

Outlook for Full-Year 2019

  • For the year, we expect RBS’s revenues to grow by 1.5% to £13.6 billion while net income margin is expected to improve from 12% in 2018 to 18% in 2019 on the back of strong revenue growth, lower operating expenses and a lower effective tax rate.
  • We expect RBS’s EPS for full-year 2019 to be around £0.20. Using this figure with our estimated forward P/E ratio of 7 and a GBP-USD exchange rate of 1.3, this works out to a price estimate of $8 for RBS’s shares, which is roughly 20% ahead of the current market price.

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