RBS reports first profit in a decade but higher costs loom
Royal Bank of Scotland clambered back into the black in 2017 for the first time in a decade, though though the taxpayer-owned bank took a late hit from legacy charges and warned of higher restructuring charges in 2018.
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Total income of £13.1bn for 2017 was stronger than the £12.96bn City analysts expected and the fourth-quarter loss of £583m led to a full year operating profit of £2.2bn and a profit attributable to shareholders of £752m versus the huge £6.95bn loss the year before. Statutory earnings per share came in at 6.3p and there was no dividend, as expected.
Net interest margin, a bank's crucial measure of the difference between lending and saving rates, was squeezed five basis points to 2.13% over the year but cost cutting was key to the return to profits, with adjusted operating expenses reduced by £810m or almost 10% on the previous year.
RBS still has some sizeable legacy issues hanging over it, with £760m of litigation and conduct costs paid in the fourth quarter but annual costs of this type of £1.3bn were a lot lower than the prior year. Payments in the year included charges and related provisions in the US from the mis-selling of residential mortgage-backed securities (RMBS), further provisions in relation to settling the 2008 rights issue shareholder litigation and an additional £175m PPI provision.
The balance sheet was strengthened significantly over the year, with the common equity tier-1 capital ratio increased by 250 basis points to 15.9%, despite the further legacy costs. Return on tangible equity rose to 8.8% from 1.6% on an adjusted basis.
RBS expect to maintain a CET1 ratio in excess of its 13% target given the substantial additional charges and costs likely in the coming quarters, including a settlement with the US Department of Justice over RMBS, future potential pension contributions, risk-weighted asset inflation as a result of IFRS 16, Bank of England mortgage floors and Basel 3 amendments, and the collective impact of these items on its stress test results.
Chief executive Ross McEwan, about whom there have been rumours that he is being lined up for a move elsewhere, reiterate his medium term outlook for both return on tangible equity and the cost:income ratio.
"We also now intend to accelerate the transformation of the bank which necessitates increased investment and innovation spend together with additional restructuring costs. As a result operating costs, excluding restructuring and litigation and conduct costs, will reduce compared with 2017, but the rate of cost reduction will be materially lower than in 2017."
Expected restructuring charges are being increased from £1bn to around £2.5bn across 2018 to 2019, only a small amount of which related to the reintegration of the former Williams & Glyn business, with the majority of costs driven by costs associated with the accelerated transformation.
McEwan said the introduction of IFRS9 will be impairments are expected to be more volatile and RBS highlighted potential downside risks, and with the current high level of UK household debt and real wage compression, any increases in unemployment and interest rates present a threat to retail impairment rates.
RBS shares fell more than 3% to 271.8p in early trading on Friday.
Yes RBS was back in black but the first profit in a decade "is largely due to the ongoing delay in finalising a settlement with the DoJ regarding historical US RMBS mis-selling" said analyst Gary Greenwood at Shore Capital.
He said adjusted profitability was slightly below consensus forecasts, "but with a much stronger than consensus expected year end core tier 1 ratio", while income, costs and impairments were all slightly worse than expected.
Neil Wilson at ETX Capital said it "seems like the worst is over and profits should start to come in longer term" but that McEwan "may wish to keep the champagne on ice" as concerns remain.
"We must urge caution around the investigation into mortgage backed securities by the Department of Justice. RBS says it has earmarked £3.2bn ($4.4bn) for this so far but it is likely to be significantly higher than that, based on similar DoJ investigations. RBS continues to stress that ‘substantial additional charges and costs may be recognised in the coming quarters’. Meanwhile there remain concerns around UK investigations (Libor, GRG) which will continue to weigh."
Wilson noted that NIM is a "fair bit below" peers "and should temper optimism resulting from the first profit in ten years" but gave RBS credit for strong capital generation and much stronger adjusted RoTE. "This suggests that once the DoJ investigation is resolved and the government starts selling off its holding, there may be some largesse to distribute to shareholders in the longer term."