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FINANCIAL INSTITUTIONS
ISSUER COMMENT27 October 2017
Contacts
Daniel Forssen,CFA +44.20.7772.1553Associate [email protected]
Alessandro Roccati +44.20.7772.1603Senior Vice [email protected]
Laurie Mayers +44.20.7772.5582Associate [email protected]
Nick Hill [email protected]
CLIENT SERVICES
Americas 1-212-553-1653
Asia Pacific 852-3551-3077
Japan 81-3-5408-4100
EMEA 44-20-7772-5454
The Royal Bank of Scotland Group plc3Q17 results: Cost reductions and lower litigation costssupported moderate profit; capitalisation further increased
In Q3 20171 2, The Royal Bank of Scotland Group plc (RBS, LT senior unsecured Baa3 stable)reported a net profit of £392 million relative to a loss of £469 million in the prior year.This corresponds to an annualised after-tax return on risk-weighted assets (RWAs) of 74basis points (bps), compared to negative 78 bps a year earlier, and an annualised after-tax return on equity of 3.7% (3Q16: negative 4.0%). RBS’s improved reported quarterlyperformance was driven by lower operating expenses, which offset higher non-core losses.Capital strengthened in the quarter, bringing the Common Equity Tier 1 (CET1) ratio to 15.5%(+70 bps) supported by a reduction in risk weighted assets (RWAs) and the attributable profitfor the period. We view the continued return to profit and increase in in capitalisation aspositive, but ratings neutral.
Positive underlying revenue trend, cost reductions and lower litigation costs.Adjusted revenue improved across nearly all main businesses and non-core losses reducedsubstantially. RBS achieved a further £214 million in net cost reductions (both in the coreand non-core divisions) and stated it is on track to meet its £750 million 2017 cost reductiontarget (94% met in the first nine months). Credit impairments were flat relative to the prioryear. Litigation and conduct costs reduced to £125 million (Q3 2016: £425 million).
Further de-risking achieved: RBS further reduced its Capital Resolution legacy assetportfolios by £3.5 billion RWAs to £23.1 billion RWAs in the quarter (Exhibit 1), whichincludes £7.0 billion of Alawwal3 related RWAs. RBS already met its end-2017 target of£15-20 billion of RWAs in Capital Resolution excluding Alawwal in Q2 and will fold the non-core unit into the core business from next quarter. The group incurred a large disposal lossof £446 million and other adjustments in the quarter relating to the non-core book and re-iterated its guidance of £2 billion of non-core lifetime disposal losses (£1.6 billion incurred toend-September 2017).
Capitalisation significantly strengthened. Further RWA reductions in the non-core book,managed reductions in the core book and the profit for the quarter led to a 70 basis point(bps) improvement in RBS’s CET1 ratio to 15.5%, solidly above the UK peer median of 12.6%at end-September 2017. We expect RBS to maintain this higher level of capitalisation in theface of short-term headwinds of litigation matters. RBS’s leverage ratio increased by 20 basispoints in the quarter to 5.3%, well above the current 3% minimum regulatory requirementand well above the UK peer median of 4.2% at end-September 2017.
MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS
Exhibit 1
Exhibit 1 Common Equity Tier 1 (CET1) ratio and Tier 1 Leverage Ratio relative to UK peers, end-September 2017 (PRA end-point basis)
15.5%
14.1%
13.1%12.1%
10.9%
5.3% 5.0%4.4% 3.9% 3.8%
0.0%
3.0%
6.0%
9.0%
12.0%
15.0%
18.0%
Royal Bank of Scotland Lloyds Barclays Santander UK** HSBC Bank plc*
CET1 Ratio Tier 1 Leverage ratio Median UK peers CET1 ratio (12.6%) Median UK peers leverage ratio (4.2%)
*CET1 ratio and leverage ratio at end-June 2017 ** CET1 ratio at end-September 2017, leverage ratio at end-June 2017. Leverage ratio reflects unmodified UK leverage ratio.Source: Company financials, Moody's
Credit risk improved, supported by non-core run off and decreased problem loans in several core segments. US DoJlitigation still outstanding. The group’s non-performing loan (NPL) ratio declined to 2.7% at end-September 2017 from 2.8%at end-June 2017. RBS has £2.8 billion reserves to cover the outstanding US Department of Justice (DoJ) and other RMBS-relatedlitigations. No material development has occurred in relation to the DOJ RMBS investigation. In October, RBS announced a $44 millionsettlement on a separate RMBS matter with the United States Attorney for the District of Connecticut, including a $35 million penaltyand $9 million of customer reimbursement (fully covered by existing provisions). RBS booked no further payment protection insurance(PPI) provisions in the quarter; remaining PPI provisions stand at £979 million .
The group's funding and liquidity position remains strong. RBS reported a Basel III Liquidity Coverage ratio of 147% and a NetStable Funding Ratio of 126% at end-September 2017. Liquid resources at £177 billion were well in excess of £69 billion wholesalefunding.
Operating profits by main line of business (all comparisons are made to Q3 2016, unless otherwise indicated).
Exhibit 2
Reported quarterly pre -tax profits by business line
-5,000
-4,000
-3,000
-2,000
-1,000
-
1,000
2,000
Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017
£ m
illio
n
UK PBB Ulster Bank Commercial Banking Natwest Markets Capital Resolution Other
Note: UK PBB denotes UK Personal & Business Banking. Results for Private Banking are included in ‘Other’.Source: RBS’s Excel data supplement
This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page onwww.moodys.com for the most updated credit rating action information and rating history.
2 27 October 2017 The Royal Bank of Scotland Group plc: 3Q17 results: Cost reductions and lower litigation costs supported moderate profit; capitalisation furtherincreased
MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS
The UK Personal & Business Banking (UK PBB) division, one of the group’s key credit strengths, reported an operating profit of £734million, up 29% versus the prior year. The improvement was driven primarily by one-off gain on sale of £168 million. Excluding this,net interest income grew by 4%, reflecting primarily higher income from credit cards. Net interest margin of 2.87% was down 9 basispoints (bps) compared Q3 2016. Gross lending increased 6.1% from end-2016 driven by mortgages and business lending, while creditcard balances decreased by 5% during the same period. Adjusted operating expenses decreased 3%, reflecting lower staff costs andothers costs, as RBS progresses in reducing its cost base.
Ulster Bank RoI (Ulster Bank Ireland DAC, LT deposits Baa2 positive, BCA ba1) generated an operating profit of €36 million, downfrom €69 million in the prior year. The result primarily reflects lower credit reversals and lower net interest income (-8%), partly offsetby lower operating expenses (-6%). Net interest margin decreased 4bps to 1.58%.
The Commercial Banking (CB) division, reported a 6% decline in operating profit to £334 million. Higher impairment losses, whichrelated nearly all to the construction sector and primarily to a single name exposure, were not offset by higher revenues and loweroperating expenses. Net interest income increased by 7% driven by deposit volume growth and re-pricing actions, while net interestmargin improved 2 basis points to 1.74%. Adjusted operating expenses decreased by 6%, reflecting primarily staff cost reduction as RBSprogressed on its cost savings initiatives. Adjusted cost-income ratio was 43%. In the quarter, CB exited some customer relationshipswhich were not generating adequate risk-adjusted return. In particular, commercial real estate lending decreased 7% in the quarter to£15.7 billion.
Natwest Markets recorded an operating profit of £44 million, down 51% relative to the same period last year. The decline primarilyreflected lower trading income (-27%) partly offset by lower operating expenses (-8%). On an adjusted basis, operating profitdecreased 48% to £95 million. Following a strong Q3 2016 which benefitted from substantial client activity from the UK referendumand USA election ramp up, revenues were down in Rates (-33%) and Currencies (-13%), and was partly offset by an improved resultfrom Financing (+26%). Adjusted operating expenses declined by 11% primarily reflecting the prior year was impacted by a one-offinvestment spend. The division’s adjusted cost-income ratio was 76%. This compares to a 2020 divisional target of circa 55%, whichRBS expects to meet mainly through further annual cost base reductions. Achievement of this objective will assist the bank in returningto sustainable profitability.
RBS’s non-core division Capital Resolution reported an operating loss of £479 million, in line with a loss of £454 million in Q3 2016.The division’s results were impacted by a large trading loss of £462 million relative to a trading profit of £182 million in the prior yearand partly offset by an impairment release, and lower operating expenses. The trading loss included £446 million of disposal lossesas RBS sold legacy assets in the quarter. Adjusted expenses reduced by 65%, primarily the results of lower staff costs. RBS continuedto downsize its capital markets business through its Capital Resolution unit, which is credit positive for RBS’s bondholders due to thegreater earnings volatility and tail risk inherent in these businesses.
Ratings ConsiderationsWe rate RBS Group's long-term debt Baa3. The ratings outlook is stable, reflecting our view that towards the end of the next twelveto eighteen months the bank will be more advanced in its complex restructuring exercise, have reduced non-core operations to asmall residual and will begin to generate more stable and sustainable earnings. On 27 September 2017, we incorporated our views onRBS’s planned organisational changes to implement UK structural reform (ring-fencing) by 1 January 2019 and changed the outlookson the A2 long-term deposits and A3 long-term senior debt of The Royal Bank of Scotland plc (BCA baa3) to negative from stable.At the same time we changed the outlook to positive from stable on the A2 long-term deposit ratings of National WestminsterBank PLC (BCA baa3). The change in the outlooks reflects our view on the likely direction of these subsidiaries' ratings, following theimplementation of forthcoming ring-fencing regulations.
Endnotes1 All figures in this report relate to Q3 2017 and comparisons are made to Q3 2016, unless otherwise indicated. All results are on a RBS reported basis unless
otherwise stated be on an adjusted basis. RBS adjusted basis; excludes litigation and conduct charges, restructuring charges, fair value changes in owndebt, gains/losses on redemptions of own debt, disposal gains/losses, and other items.
2 The operating profit in the quarter included £374 million of adverse significant items (Q3 2016: £1.1 billion net adverse items) including £244 million ofrestructuring costs (Q3 2016: £469 million) and £125 million of litigation and conduct costs (Q3 2016: £425 million).
3 Alawwal bank (Foreign Currency LT deposits A3 stable, BCA baa2). BCA: Baseline Credit Assessment.
3 27 October 2017 The Royal Bank of Scotland Group plc: 3Q17 results: Cost reductions and lower litigation costs supported moderate profit; capitalisation furtherincreased
MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS
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REPORT NUMBER 1098025
4 27 October 2017 The Royal Bank of Scotland Group plc: 3Q17 results: Cost reductions and lower litigation costs supported moderate profit; capitalisation furtherincreased
MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS
Contacts
Daniel Forssen,CFA +44.20.7772.1553Associate [email protected]
Alessandro Roccati +44.20.7772.1603Senior Vice [email protected]
CLIENT SERVICES
Americas 1-212-553-1653
Asia Pacific 852-3551-3077
Japan 81-3-5408-4100
EMEA 44-20-7772-5454
5 27 October 2017 The Royal Bank of Scotland Group plc: 3Q17 results: Cost reductions and lower litigation costs supported moderate profit; capitalisation furtherincreased
