Since the economic downturn of 2008, understanding the performance of The Royal Bank of Scotland Group (NYSE:RBS) requires looking through a long list of “one-time and other items,” which the U.K.-based bank reports alongside its operational performance. The figures for the last quarter and full year 2012, which RBS reported on February 28, are no different in this regard. But the list of one-time charges have two major additions – a £700 million ($1.1 billion) charge from mis-selling interest-rate products (see U.K. Banks Now Sued Over Derivatives Mis-Selling) and the £381 million ($612 million) fine related to the LIBOR scandal (see RBS Foots $612 Million Bill To Settle LIBOR Manipulation Charges) – which pushed the total amount of such charges for the quarter to an unprecedented £3.1 billion ($4.7 billion).
The resulting net loss figure of £2.6 billion ($3.9 billion) for the quarter and £6 billion ($9.1 billion) for the year is what led to a 7% decline in the bank’s share price over the day’s trading. There are some notable improvements in the group’s performance across operating divisions. While the bank’s U.K. retail business reports higher revenue and profit figures, total impairment charges continue to fall, helping profitability. The bank’s decision to cut down on its investment banking operations considerably has also started showing results, with margins for the division rising. Besides this, the bank’s announcement to float its U.S. retail banking business as well as to slash its trading portfolio further look like steps in the right direction (see RBS Earnings: More Investment Banking Cuts And Citizens Spin-Off). Keeping these factors in mind, we have updated our price estimate for RBS’s stock from under $10 to $11.
Investment Banking Margins Upbeat
Since last January, RBS has been hard at work revamping its loss-making and capital-intensive investment banking. The group started by announcing its decision to exit the equities business almost completely (see RBS Shrinks by a Third, Fixed Income Focus From Here). Since then, its M&A, cash equities, corporate broking and equity capital markets operations have been sold or shuttered, leaving the bank to focus only on its fixed-income business. In the process, RBS also managed to release a sizable chunk of capital which was locked-up as trading assets.
As a result of these efforts, the division has shown considerable improvement in profit margins, with a reduction in expenses more than making up for the reduction in revenues. As can be seen in the chart above, margins for RBS’s investment banking operations shot up from around 20% in 2011 to almost 34% in 2012. And the improvement is only expected to continue over the coming years.
RBS Is Yet To Find A Way To Plug Ulster Bank Losses
The way we see it, the biggest threat to RBS’s value is still its Ulster Bank unit – the group’s retail banking business in Northern Ireland. The business has been bleeding cash for well over three years now, with RBS being forced to write-off £1.16 billion ($1.76 billion), £1.38 billion ($2.09 billion) and £1.36 billion ($2.06 billion) in impairment losses related to the unit for the years 2010, 2011 and 2012 respectively.
And while we expect the situation in Ireland to start showing an improvement beginning this year, a delay in macro-economic recovery in the region presents a significant downside to RBS’s share – something that can be understood by making changes to the chart above.