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RBS profits surge but US litigation looms
Royal Bank of Scotland Group reported a threefold increase in first quarter net profits as the cost of restructuring and litigation fell, but there remains a looming threat of a sizeable penalty from US authorities.
The taxpayer-owned bank reached a $630m settlement with New York authorities during the period to settle claims over the mis-selling of residential mortgage-backed securities in the run-up to the financial crisis, but is yet to agree an expected multi-billion-dollar penalty with the US Department of Justice that is likely to far eclipse rival Barclays' recent $2bn settlement.
With Barclays' fine related to $31bn of US securities issues, RBS's $140bn of securities might suggest a settlement of around $9bn, though some reports have pointed to as much as £13bn. So far, the bank has set aside $4.3bn.
RBS generated income of £3.3bn in the first three months of the year, up 3% on the first quarter last year and 8% higher than the fourth quarter, as well as beating the average analyst forecast of £3.2bn.
With costs falling 2.1% and net interest margin (NIM), the crucial difference between interest generated on income and paid out on deposits, was 2.04% in the quarter compared with 2.24% a year ago and 2.06% in the fourth quarter of 2017, which the bank said reflected competitive pressure and the impact of the new IFRS accounting standards.
The period saw £209m of restructuring charges, now renamed 'strategic costs' as part of the planned £2.5bn of restructuring costs through 2018 and 2019 as the bank adapts to the digital age. Litigation costs in the quarter were just £19m, while the other exceptional costs was a £21m gain on redemption of own debt.
Operating profit before tax of £1.2bn was up 70.1% on the year before and beat the consensus forecast of £699m, while the fourth quarter was lossmaking due to litigation provisions. Adjusted profit before tax increased 4% to £1.4bn, also beating the expected £1.3bn.
The tier-1 capital ratio, an important measure of a bank's capital levels, improved 50 basis points to 16.4% and was just ahead of the 16.3% the market was anticipating.
Management made no change to financial guidance for the full year or beyond, with the current consensus forecast pointing to PBT of £4.9bn for 2018.
RBS shares fell 0.5% in early trading to 271p.
While underlying operating performance is improving, said analysts at Shore Capital, the outlook continues to be overshadowed by the impending US DoJ investigation into alleged historical US RMBS mis-selling, which remains a key driver of the investment case but for which the timescale is out of the group's control.
"It is interesting also to note a deterioration in Net Promoter Scores (a metric closely monitored by management) in Q1 across the business."
Analyst Nicholas Hyett at Hargreaves Lansdown said the numbers were well ahead of expectations on almost every line. "You might expect that to be good news for the shares, but with banks, not all profits are equal and revenue mix matter," he said.
"Income growth is being driven by trading activity - which is by its very nature volatile and unpredictable and so might not turn up next time round. Meanwhile loans to customers, the bread and butter of a retail bank, are shrinking and an increasingly competitive UK mortgage market means the bank isn't earning the same turn on loans that it used to. That's being offset by cost savings as the bank moves online, but having spent years streamlining the business RBS needs to show its new slimline business model can grow revenues as well as shrink costs."
On the upside, capital generation seems robust with CET1 capital ahead of target, but what management can do with the spare cash remains up in the air until the bank knows how much it has to pay as part of its impending settlement with the US DoJ.