Interactive Investor

Has forecast-busting RBS turned the corner?

25th July 2014 11:25

Lee Wild from interactive investor

Once the pariah of the banking world and still vilified in some quarters, Royal Bank of Scotland appears to have turned a corner. In fact, the taxpayer-owned lender has been doing so well it's brought forward half-year results by a week, and stunned traders chased the shares up by 15% at one point to 378p, a six-month high.

And these were impressive numbers, indeed. RBS made an extra £1 billion of adjusted operating profit during the second quarter, more than doubling last year's figure to £1.95 billion. It was over a half-a-billion more than the first quarter, too, and smashed broker Espirito Santo's forecast for just £768 million. Revenue, meanwhile, fell far less than expected, down a tenth to £ 4.93 billion and 13% ahead of Espirito's estimate.

Profit for the half-year is tipped to hit £2.6 billion, up from a paltry £708 million in 2013, driven by favourable credit conditions and good results from its capital resolutions business, the bad bank where RBS stuck all its problem loans.

Impairment losses plunged by almost £1.9 billion to £269 million, with improvements across all the core divisions. An operating loss at the bad bank of £114 million during the first quarter became a profit of £48 million three months later following a £128 million impairment write-back.

Crucially, bosses reckon credit impairment charges will remain low over the next six months, and a full-year charge of about £1 billion is half the figure expected by the City. And with the bad bank's funded assets also tipped to be down as much as half since it was set up to just £15 million by year-end, costs there are expected to tumble from an original estimate of £4-£5 billion to a far more palatable £2.5-£3 billion.

The bank is also making good progress towards achieving its target core tier-one capital ratio on a Basel III basis of 11% by the end of next year - it was 10.1% at the end of June - and at least 12% by the end of 2016, although it does warn that "ongoing conduct and regulatory investigations and litigation continue to present challenges and uncertainties and are expected to be a drag on capital generation over the coming quarters."

And chief executive Ross McEwan managed to contain his excitement briefly to warn against complacency. "We are actively managing down a slate of significant legacy issues," he said. "This includes significant conduct and litigation issues that will likely hit our profits going forward. I am pleased we have had two good quarters, but no one should get ahead of themselves here - there are bumps in the road ahead of us."

Clearly, this is a fantastic result for RBS. And the sooner interest rates rise, the better. As Investec Securities points out, RBS is one of the most geared UK banks to a rising rate environment. It discloses a net interest income sensitivity of £416 million for a 1% upward move in sterling interest rates and £175 million sensitivity for a similar move in US dollar rates.

UK taxpayers will continue to own a substantial part of RBS for years to come and there are plenty of legacy issues yet to unwind. And despite easing capital adequacy concerns and return on tangible equity of 7%, RBS shares are already trading at tangible net asset value of 376p per share. Many in the Square Mile think that's about right for now.

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.