Despite recent dramatic headlines, little has changed at RBS
The recent decision of Royal Bank of Scotland (RBS) to split its assets across so-called internal ‘good’ and ‘bad’ banks has generated a huge amount of commentary and coverage but if, as we prefer to do here on The Value Perspective, we step back for a moment and take a longer-term view of the situation, has anything actually changed?
Ever since the credit crisis, RBS has operated a ‘non-core’ division, whose job it has been to manage the highest-risk loans the bank does not expect to be repaid. RBS may have shuffled some assets between its ‘non-core’ and ‘core’ pots but the £38bn of assets to be managed within the new internal bad bank is not all that far away from the £35bn or so of assets expected in the old non-core division.
So something that has consumed a great deal of time, effort and public money has resulted in a similar pot of assets – as it happens, some two-thirds are exactly the same assets – being run in the same way as before, only under a different name. Here on The Value Perspective, we would argue the media coverage that has followed has essentially been ‘much ado about nothing’.
Indeed, an internal bad bank was arguably the only plausible outcome for RBS because an external version would have been prohibitively expensive, would have been unlikely to receive approval from RBS’s minority shareholders would almost certainly have breached the European Union’s rules on state aid for banks.
One thing that has changed, however, is that whereas, in the past, RBS, its regulator and the government often seemed to be pulling in opposite directions, with the resultant destruction of a lot of value, the arrival of RBS’s new chief executive Ross McEwan has coincided with the three parties appearing to work as a more cohesive unit, which can only be to the bank’s benefit.
Meanwhile RBS continues to perform reasonably well as an actual business, with the underlying return on equity for the core bank at 8% and expected to rise above 10% as RBS proceeds with a review of its Ulster Bank assets and the sale of its US operations in the New Year. Furthermore, it is accelerating its balance sheet clean-up by triggering a £4.5bn charge on ‘impaired assets’ in the final months of this year.
In the table below, which compares some of the key metrics of Barclays, Lloyds and RBS, RBS stands out for two reasons. The first is it is the cheapest of the three, which as a group are all cheaper than their European counterparts, and the second is its balance sheet is still pretty solid – something highlighted by the ‘provisions to loans’ number.
|UK high street banks – key metrics|
|Tangible book value (p)1||
|Core Tier 1 ratio (%)2||
|Leverage ratio (%)3||
|Provisions to loans (%)||
Source: Schroders as at 05/11/13. RBS is proforma for a £4.25bn impairment in Q4 this year and Barclays is proforma for the recent rights issue.
Provisions to loans is essentially a buffer against new things going wrong and, alongside a reasonable Core Tier 1 ratio and a best-in-class leverage ratio, shows RBS offers a decent level of downside protection. At the same time, the bank’s tangible book value, which as regular visitors to The Value Perspective will know is our preferred measure of potential upside, continues to look attractive.
1 Tangible book value: A measure of a
bank’s fair value – obtained by dividing a bank’s tangible net assets by
the number of its shares in issue – that gives investors an idea of the
changing upside in the business.
2Core tier 1 ratio: A measure of a bank’s financial strength – obtained by dividing a bank’s core equity by its risk-weighted assets – that indicates how safe or otherwise it should be as an investment. A larger number indicates greater financial strength.
3Leverage ratio: Another measure of a bank’s financial strength – obtained by dividing a bank’s core equity by its un-weighted assets – that again indicates how safe or otherwise it should be as an investment
Image by Elliott Brown