Interactive Investor

RBS joy short-lived after Q3 results

28th October 2016 11:58

Lee Wild from interactive investor

Royal Bank of Scotland shares surged by 6% in reaction to reasonable third-quarter results published Friday. That took the rally to 22% in less than a fortnight, but in a market that's distinctly jittery, investors quickly decided that a big loss, a warning it would miss long-term targets, confusion over Williams & Glyn and potentially huge fines in the US were reason enough to trouser profits.

Just 90 minutes after the opening bell, RBS shares were back in negative territory. An attributable loss of £469 million was smaller-than-expected, certainly by analysts at JP Morgan, who'd pencilled in £697 million. RBS, in which the taxpayer still owns a 73% stake, made a £940 million profit a year ago.

Strip out a whole host of nasties, including restructuring costs of £469 million, litigation and conduct costs of £425 million and a £300 million deferred tax asset impairment, and operating profit jumped from £826 million in 2015 to a bigger-than-expected £1.3 billion.

But, of course, you can't just ignore those big "one-offs", and we're warned that there'll likely be heavy fines in future. There was no further provision for Payment Protection Insurance (PPI) claims this time, true, but more charges are inevitable.

And RBS is already under investigation by the US Department of Justice (DoJ), which last month slapped a $14 billion (£10.6 billion) fine on Deutsche Bank for issuing and underwriting residential mortgage-backed securities (RMBS) - subprime mortgages - between 2005 and 2007. RBS faces similar charges.

A failure to get rid of its Williams & Glyn (W&G) operations also increases estimates for restructuring costs from over £1 billion to £1.5 billion. That's because of the decision made in August to scrap a project to build W&G a separate banking platform.

On Thursday, challenger bank CYBG, spun out from National Australia Bank at the start of the year, launched an audacious bid for W&G. Integration would be a massive undertaking, however, and many doubt it will happen. Far better for RBS (and W&G account holders) that it thrash out a deal with former bidder Santander.

The potential damage to RBS's capital from these issues means a return to dividends is no nearerBut while RBS says talks are ongoing, there's no way any of the deals currently on the table will meet a European Commission (EC) deadline to sell the 314 branches by the end of 2017.

The CEO, New Zealander Ross McEwan, is in talks with both HM Treasury and the EC about next steps, but admits he's unsure what the consequences will be.

Elsewhere in the numbers, RBS warned it would miss its long-term cost/income ratio and returns targets by 2019. There was also adjusted return on equity (ROE) of 4.6%, a 50-basis point increase in the Common Equity Tier 1 (CET1) ratio to 15%, ahead of its 13% target, and decline in tangible net asset value (TNAV), caused by the attributable loss, to 338p from 345p in June and 352p at the end of 2015.

There was also pressure on margins, with net interest margin (NIM) down four basis points on the previous quarter to 2.17%.

Given the potential damage to RBS's capital position from a number of issues here, a return to the dividend list is no nearer.

"With RBS shares trading at 0.6 times for return on net asset value (RoNAV) of 4.7% in 2018 and uncertainty over dividends and capital return, we are 'underweight' with a price target of 175p," said JP Morgan analyst Raul Sinha.

"Following the UK’s vote to exit the EU, we see material uncertainty around the post Brexit macroeconomic environment for the UK. We see potential for further downside from rising financial stability concerns for Scotland-exposed UK banks if a referendum for a Scottish exit from the UK were to be called again."

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.