Dividend optimism as RBS rips up sale plan

Royal Bank of Scotland has ripped up plans to sell its branch network just days before it publishes results for 2016. If its Treasury-backed idea is sanctioned by the European Union (EU), the added clarity will make RBS far more attractive to investors. Analysts are already raising forecasts and the share price is up over 6% Monday.

Williams & Glyn (W&G) - 307 RBS branches in England and Wales plus NatWest banks in Scotland - was put up for sale in 2009 when the UK government took an 84% stake. "That's state aid," said the EU, which ordered Edinburgh-headquartered RBS to sell up south of the border.

Finding a buyer for W&G has proved impossible, however, and there's no way a sale agreed now would ever complete by the end-2017 deadline. The process is also estimated to have cost the bank as much as £2 billion. So it's a relief that RBS has come up with a plan which looks workable. It would also both boost profits and make a return to the dividend list a possibility far sooner than is currently the case.

It will cost £750 million - a charge will be taken in Friday's fourth-quarter and full-year numbers - but this "revised package of remedies to promote competition in the market for banking services to small and medium enterprises" stands a great chance of winning over EU decision makers.

RBS will use that money to set up a fund for challenger banks to access business banking capabilities, help challengers incentivise smaller businesses to switch from RBS accounts - so-called "dowries", let business customers at challenger banks access its cash and cheque handling, and establish an independent fund to invest in fintech.

This is not a done deal by any stretch, but many in the City believe it will happen, probably before the end of 2017, and that it marks "an important turning point for RBS". It's why the shares traded as high as 258p Monday, their best in 12 months.

"The proposed solution is not only EPS accretive, but should also make RBS's strategic targets easier (W&G produces a high-teens [return on equity], sub-50% cost/income ratio), and likely brings forward the resumption of dividends this time next year with larger capital returns beyond that," writes Deutsche Bank analyst David Lock.

Including W&G, which makes about £400 million underlying profit every year, bumps up forecasts for years when analysts had factored in a sale. It means Lock's estimates rise by about 10% and his price target from 220p to 252p.

Rohith Chandra-Rajan at Barclays increases his target by 25% to 250p. He admits risk remains around other non-operating issues like US subprime mortgage fines, and it must improve returns in its core business, but "clarity on many of the issues facing RBS could emerge in the coming months".

"Addressing these non-operating issues in 2017 should provide a clearer path towards the normalisation of the business, and also brings forward our expectations of dividend resumption to FY17," he says, believing progress here alleviates "much of the downside risk".

Hurdles

As Lock points out, RBS chiefs have said the three hurdles are settling litigation, exiting W&G, and passing the Bank of England stress tests. Remember, a further £3.1 billion provision was taken in January to cover a fine from the US Department of Justice.

"The W&G announcement we think means that restarting a dividend in FY17 (ie declared in Feb 2018) is now a realistic possibility," writes Lock, pencilling in a 5p payout for 2017 "followed by more material dividends in 2018/19".

Ian Gordon, banks analyst at Investec Securities and RBS sceptic, increases forecasts for attributable losses in 2016 to £6.3 billion from £5.7 billion. Estimates of tangible net asset value (TNAV) also fall by 6p to 304p, down from 352p in 2015, and Gordon sticks with his 'sell' rating given he thinks profits are still two years away.

Clearly, there are still problems for RBS to overcome, and its shares have got ahead of themselves on today's news - they currently trade on almost 15 times Lock's forecasts for 2017. If everything goes RBS's way, that does drop to less than 11 times for 2018, however.

Buying ahead of results on Friday is fraught with risk, too, but the lender will resolve its issues in time, and probably sooner than many had feared. If not an obvious buy just yet, RBS shares certainly just got interesting. Resolution of the US toxic mortgage scandal within its current provisions could prove a further catalyst.

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.